While we documented (and predicted [6]) the surge in October 31 T-Bill yields, now that the market is increasingly pricing in the probability of a (supposedly brief) technical default of short-term US debt around October 17, aka the "X-Date [7]", a more disturbing development has been the rapid rise in November 14 Bills [8], as increasingly more traders become concerned not only about a failure to successfully negotiate away the debt ceiling, but the possibility of a protracted debt ceiling fight continuing well into November. So just what are the US government's key obligations in the immediate aftermath of the X-Date? Here, once again, is a breakdown of key events and cash "deliverables."
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And in a world in which the current "autopilot" course of events is untouched, the increasingly most likely option for the US Treasury would be "payment prioritization", one which focuses on the sacrosanct debt-obligations including rollover and interest, and puts other, less critical payments on the backburner.
Two such possible scenarios are presented below:
Priotiziation, or selective payment of obligations.
- If we reach the X Date, Treasury might either prioritize payments or make full days’ worth of payments once they receive sufficient revenues to cover all of a day’s obligations.
- Interest on the federal debt would likely be prioritized in either scenario – it is paid on a separate computer system (FedWire).
- Scenario # 1: Pay some bills, but not others
- Treasury might attempt to prioritize some types of payments over others. Prioritized payments would be made on time, others would not.
- This option may not be possible to implement using Treasury’s current financial systems. It would involve sorting and choosing from nearly 100 million monthly payments.
If the X Date arrives on October 18 (the beginning of the BPC range):
- Treasury would be about $106 billion short of paying all bills owed between October 18 and November 15 (20 business days).
- Approximately 32% of the funds owed for the period would go unpaid.
- The reality would be chaotic:
– Unfair results, unanswered questions
– Treasury picking winners and losers
– Public uproar
– Intense global media focus
[10]
[11]
- Scenario # 2: Make all of each day’s payments together once enough cash is available
Treasury might wait until enough revenue is deposited to cover an entire day’s payments, and then make all of those payments at once.
(For example, upon reaching the X date, it might take two days of revenue collections to raise enough cash to make all of the payments due on day one. Thus, the first day’s payments would be made one day late. This, of course, would delay the second day’s payments to a later day.)
- In the 2012 OIG report, some senior Treasury officials stated that they believed this to be the most plausible and least harmful course of action.
- Since debt operations are handled by a separate computer system, these payments could likely still be prioritized under this scenario.
The problem, as noted above is that no matter what happens absent a compromise, "Treasury would be about $106 billion short of paying all bills owed between October 18 and November 15 (20 business days)."
And since the specter of a debt default is too unfathomable for HFT algos (and what little remains of carbon-based traders) to consider, expect the market to continue levitating into the X-Date, which of course will send just the wrong message of urgency to both Obama, despite his stern warning to Wall Street that a market selloff may be just what is needed [12], and of course the very theatrical Congress.