Debt Ceiling Doubts Soar As 'Kink' In T-Bill Curve Builds

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by Tyler Durden
Tuesday, Aug 17, 2021 - 06:15 PM

Even as (some) Republicans and Democrats came together a week ago to pass the Infrastructure Investment and Jobs Act, another political battle between the two is shaping up in Washington - this time over raising the debt ceiling.

As a reminder, the debt ceiling, the federal government’s borrowing limit, can only be raised through congressional action. Should Congress fail to raise the borrowing limit, the U.S. government would face default, a move which Treasury Secretary Janet Yellen says should be “unthinkable.” Such a default, Yellen warned, “would have absolutely catastrophic economic consequences.”

As Joseph Lord notes, the deadline for averting a default is fast approaching - though the Treasury has resorted to “extraordinary measures” to continue to fund U.S. obligations, the federal government will run out of money entirely by October without the go-ahead from Congress to issue new bonds.

Despite these risks, this dire threat has long been used by minority parties in the House to extract concessions from the opposition. Republicans used the threat of not raising the limit especially effectively during the Obama administration, forcing the former president to agree to spending cuts in exchange for congressional Republicans raising the debt ceiling.

Specifically, Republicans led by Sen. Ron Johnson (R-Wis.) have unveiled a new strategy that would force congressional Democrats to take the brunt of the blame for increasing the limit. Almost every Republican senator in the body signed a petition created by Johnson vowing to not vote for a debt ceiling increase.

“We, the undersigned Republican Senators, are letting Senate Democrats and the American public know that we will not vote to increase the debt ceiling, whether that increase comes through a stand-alone bill, a continuing resolution, or any other vehicle” the letter read.

Predictably, Democrats were displeased with the move, and several leaders in the party expressed that they felt that the Republican senators were bluffing.

“I can’t believe Republicans will let the nation default,” Senate Majority Leader Chuck Schumer (D-N.Y.) said at a press conference.

Given the consequences of not extending the debt ceiling, it is unlikely that Congress will not act, but in the meantime, uncertainty is starting to show in the markets.

As Praveen Korapaty, head of U.S. interest-rate strategy at Goldman Sachs, notes, "In recognition of this risk, T-bills maturing mid-October to mid-November have started to cheapen relative to neighboring issues."

Source: Bloomberg

For now, however, Korapaty notes that the magnitude of the cheapening - which means yields on the securities are higher than those of surrounding issues indicated by the 'kink' seen above - is currently modest (about 1-2bps) when compared to prior episodes, where bills have cheapened anywhere from 10-50bps.

“However, the kinks in the bill curve have tended to get more pronounced only much closer to the actual deadlines, which is still over a month and a half away”

For context, here is the evolution of the spread between October and November T-Bill yields...

Source: Bloomberg

Korapaty adds that the availability of a large amount of an alternative risk-free assets such as the Fed’s reverse repos "may make some investors more willing to avoid bills with maturities at risk."

There remains significant uncertainty however as to the date at which the money runs dry - which explains the breadth of the kink in the first chart above - as Bloomberg Intelligence strategists Ira Jersey and Sean Savage

"This year it is far more difficult to accurately calculate the date the government runs out of cash and borrowing capacity, which means the market may continue to price in for a range of potential problem dates in the bill market." That's why there is "no smoking gun nor consensus problem date built into market pricing."

However, they do note that their model "shows the U.S. Federal government running out of debt capacity and cash in early November, leading to a technical default on some debt."

Press secretary Jen Psaki noted last week that: “Raising the debt limit has been done 80 times … in a bipartisan fashion. Ninety-nine percent of [the debt] existed before President Biden took office.”


She added that Republicans would also face pressure from “former leaders from both sides of the aisle [who] are eager to see Congress raise the debt limit and not face default.”

We shall see...