One of the side effects of the US hitting its debt ceiling in mid-May is that while the components of its total debt have been shifting, with total marketable debt slowly grinding higher, while intragovernmental holdings (i.e., government retirement pension accruals) declining, the total thing has been flat as a pancake at just $25 million below the mandated ceiling. Since May 16 (or 57 working days now), total US debt has been $14.345 billion and not a penny more. Yet the issue is that with the US expected to have a roughly $1.5 trillion budget deficit in the calendar 2011 year, the ongoing contraction in debt issuance is only temporary. Basically when and if the debt ceiling is lifted, the Treasury will not only have to issue as much debt as before, but it will have to issue massively more in the short term to catch up to the ongoing run rate, and also in order to prefund the same retirement accounts it has been plundering for the past 6 months. So here's the math. As the chart below shows, since May 16, the cumulative divergence between where total debt is and where it should be is now a whopping $265 billion. That's right: when the debt ceiling cap is finally lifted, and it will be lifted, with republicans "kicking and screaming", Geithner will suddenly find himself needing to plug a gap of over 2 months worth of accrued treasury issuance. Mathematically, this means the Treasury will have to sell not the $100 billion or so in net debt but well over double that in August and September. And this will happen at a time when there is no QE2 to soak up the excess slack.
Two other things to note: the primary reason for the collapse in total debt in addition to retirement fund "disinvestment" is that the Treasury has not been rolling its Bill maturities: after all every single Bond and Note weekly auction has so far gone down just as expected with no delays. Another thing: we are assuming a $1 trillion run rate increase in total debt which fits with the rateof debt issuance in the early part of the year. However, as noted above, the total debt in 2011 will likely have to be 2011, which means a dramatic pick up in total issuance in the second half as Geithner scrambles to fund operations.
And one last thing to note: as has been reported elsewhere, recent tax withholdings have dropped substantially in recent weeks, which simply means that even more debt will have to be funded through debt issuance.
In other words, as Treasury prepares to flood the market with Bills of all shapes and sizes, we could see one of the biggest curve flattening moves in recent history. After all, recall what the Fed did to the RMBS space after it decided to dump Maiden Lane II in the open market.
Prepare for a repeat of just that in the short-end as soon as the debt ceiling is finally hiked.