Is A US Default Imminent: Liquidation Panic Grips T-Bills Market

While the politicians and the mainstream media are playing down any concerns about the US debt ceiling, Treasury Bill market participants are seeing chaos as the yield curve has snapped across the Sept-Oct divide with panic-buying in bills that mature ahead of the September-end (Q3-end liquidity needs), and dumping of October bills.


As Treasury Cash declines...


The T-Bill curve is steepening drastically... to its steepest yet...

As the debt-ceiling anxiety indicator is exploding...

With the short-end bid and anything maturing just after September is getting crushed...

As a reminder - USA Sovereign risk has spiked to double that of Germany's recently - the highest since Lehman...

As we noted previously, one potential catalyst for the spike in odds of an adverse outcome is that earlier today, the chairman of the conservative House Freedom Caucus said aid for victims of Hurricane Harvey should not be part of a vehicle to raise the debt ceiling.

Quoted by The Hill, Rep. Mark Meadows (R-N.C.), a Trump ally who leads the conservative caucus, said disaster aid should pass on its own, apart from separate measures the government must pick up in September to raise the nation's borrowing limit and fund the government.

“The Harvey relief would pass on its own, and to use that as a vehicle to get people to vote for a debt ceiling is not appropriate,” he said an interview with The Washington Post, signaling agreement with Trump on the approach. It would “send the wrong message” to add $15 to $20 billion of spending while increasing the debt ceiling, Meadows added.

Ironically, it was precisely the Harvey disaster that prompted Goldman yesterday to lower its odds of a debt ceiling crisis from 50% to 33%, on the assumption that it would make conseratives more agreeable to a compromise, when in fact precisely the opposite appears to have happened, and the new dynamic is now playing out in the market where the odds of a government shutdown have never been greater.

So what does it mean for the US if the T-Bill market is correct and a debt ceiling deal is not reached in time over the next 30 or so days? For an unpleasant perspective on what may happen next, here is Deutsche Bank's preview of what a debt ceiling crisis would look like:

Guide to a Debt Ceiling Crisis


If Congress doesn’t act in time and the above fallbacks are deemed untenable, the Treasuries with affected principal or coupon payments would likely be handled in two ways, according to scenarios considered by SIFMA. The first option would extend maturity and coupon payments, where payment decisions are explicitly announced by Treasury one day at a time, and both coupon and principal payments are ultimately made in full once the debt limit is raised. These securities would be able to be transferred normally, and a market for them would develop. While the security is not “defaulted” as its maturity date has been extended in systems, the extension would likely constitute a change in terms that triggers CDS.


The other outcome would a failure pay , where Treasury does not set a date for future payment, and there is no pre-announcement (or it comes last minute). A failure to pay would mean the affected securities drop off the Fed system and cannot be transferred normally. A market would eventually develop, but once there is a failure to pay and the securities are not extended in systems, they cannot be “unmatured” and maturity extended.


Regardless of whether it is a payment extension or a failure to pay, the longer Treasury remains in default, the worse the situation for financial markets. Market reactions and market functioning might be comparatively stable at first, but the concern is of widespread panic and systemic market disruptions.


As for immediate ramifications, noted that CDS would likely triggered either default scenario , as sovereign CDS is triggered by either a failure to pay, repudiation/moratorium, or a restructuring. A failure to pay occurs when a sovereign doesn’t pay principal or interest when due, with a 3 day grace period applying to that due date in the case of the US. In our view, a CDS trigger would apply to all debt obligations backed by the full faith and credit of the US government (including GNMA, FHA securities, etc.). A CDS event is unlikely to have much direct market impact, however, as net CDS exposure is a modest $1bn as of the end of July, down from about $4bn in 2013 and its peak near $6bn in 2011. As long there is no one particular bank that is overly short protection, we do not expect any knock-on CDS event. 5y CDS is currently suggesting no real concern, sitting at the bottom end of its 19-24bp ytd range. While the supply of deliverable securities is more than adequate to satisfy the outstanding contracts, demand deliverable bonds may cause distortions . The 2.25% Aug 2046 bonds are currently the cheapest-to-deliver into the CDS, and would likely trade upward in price towards recovery value.


Among Treasury market investors, money market funds are a key group possible propagation risk . Even after money fund reform, government funds continue to be quoted at a stable $1 NAV, leaving them vulnerable to perceptions around “breaking the buck,” and therefore large scale investor redemptions in an extreme scenario. Treasuries accounted for $678bn of money funds $2.7tn AUM as of the end of July, while Treasury repo makes up another $595bn (with about $150bn of that made up by RRP’s with the Fed). Money funds’ Treasury holdings tend to be concentrated in securities maturing in the first month – more than 40% of their Treasuries held at the end of July matured in August. This suggests that the bias will be for money funds to accumulate more securities maturing around the debt ceiling, though they may be cautious around specific issues. However, it’s worth noting that they then owned over $40bn combined in the October 5 bills, October 12 bills, and October 15 coupon maturities – more than 20% of the amount  outstanding. Of the $1.3tn of Treasuries (bills and coupons) that mature between October and mid-January, money funds own about 19% - potentially an important factor in the event that a default drags out. Also note that maturing notes and bill holdings are concentrated in a relatively few fund families.


Potential outflows from money funds has implications repo market . Possible forced selling of Treasuries, money funds would likely cut back on their provision of financing to banks through repo. While reforms have reduced banks’ reliance on short term funding and put them in a place to better withstand a significant reduction in availability of things like repo funding, a sharp contraction in overall repo financing would likely have ramifications for market functioning and liquidity.


In terms of market plumbing, given the reliance Treasuries managing credit risk derivatives , a default event could spread quickly to derivatives market via a sudden drop in the valuation of UST collateral. This loss in value would trigger calls for additional collateral, and given the widespread use of UST’s, it is possible that a number of market participants fail to post sufficient collateral; this would constitute a default in a centrally cleared trade. The requirement that the surviving counterparty replace the risk of that trade could subsequently result in a major revaluation of all related trades, triggering new collateral calls, and potentially create a vicious cycle.



How might the Fed might react to a major disruption?


The question is complicated by a possible reinvestment decision in the September meeting, but extracting that for the time being, there is nothing immediately apparent in the Federal Reserve Act that would preclude the Fed from purchasing defaulted Treasury securities. This would likely not be a proactive step, as the Fed would not want to be seen “bailing out” the Treasury, but given the extremity of a default situation, the Fed would be governed by its financial stability mandate.


The Fed could intervene by removing defaulted securities from the market and sell or repo non-defaulted issues to provide the market with good collateral. Additional emergency facilities similar to those seen in 2008 are another option wherein the Fed could support money funds by accepting their assets and providing liquidity. To the extent that liquidity concerns became extreme the Fed could obviously move to add further monetary accommodation especially if it perceived knock on effects to the growth and inflation outlook.


hedgeless_horseman NoDebt Fri, 09/01/2017 - 11:36 Permalink

 Our government and banks do not want solutions...

3) Pass and actually enforce a Balanced Budget Amendment  Stop enslaving us, our children, and grandchildren with more debt just to buy yourselves votes and provide passive income for the very wealthy.…

 ...and neither do most of the people.  Spend less than we make?  Unpossible!

"They sow the wind and reap the whirlwind. The stalk has no head; it will produce no flour. Were it to yield grain, foreigners would swallow it up."  Hosea 8:7  

In reply to by NoDebt

Haus-Targaryen E.F. Mutton Fri, 09/01/2017 - 11:26 Permalink

The Debt Ceiling shitshow is similar to the movie "No Country for Old Men" The first time you see it, you're like "Holy shit!  That was really intense!  I'm not sure how I like how it ended."Then the second time you see it, knowing what will happen, its just hilarious, and you find yourself laughing the entire time.  Must have the same script writer. 

In reply to by E.F. Mutton

spastic_colon Fri, 09/01/2017 - 11:20 Permalink

F**K this S**T........just more noise to keep volatility in play; same sh*t different month; hammer VIX down then regurgitate some BS about <enter crisis here> then allow VIX to rise all month long until the last two days of to change the headline into another f**king question ZH er I mean cnbs............

dogismycopilot Fri, 09/01/2017 - 11:20 Permalink

Why the fuck the Russians hold USTs is beyond me. I remember back before the 2009 crisis they were stuffed to the fucking gills with Fannie Mae and Freddy Mae bonds. That didn't work out well for them either. 

MD NoDebt Fri, 09/01/2017 - 11:47 Permalink

Trump himself said, in a campaign speech last year, that they would just print the money if there ever was a risk of default. This has been understood for decades. There's zero reason to rock the boat with a default, when the money printing option is so incredibly easy.

In reply to by NoDebt

onthedeschutes Fri, 09/01/2017 - 11:41 Permalink

Great news just in:  Rapidly strengthening Hurricane Irma just slammed into the US Debt, completely wiping out the debt and the hurricane.  We are all SAVED!!!  On to new highs!!!

aliens is here Fri, 09/01/2017 - 11:59 Permalink

Quit the fear mongering. We are not going to default. Sleazy politicans won't allow it. They'll raise the debt limit no matter what. We should default but we won't.

slobbermut Fri, 09/01/2017 - 12:30 Permalink

Yada Yada Yada...what a load of BS - The Banks DON'T want a Default thus there won't be a default; 85% + of both parties do what they are told by the banks to do.

Herdee Fri, 09/01/2017 - 13:30 Permalink

If Germany was smart they'd get the rest of their Gold out of England and the U.S. before it is ceased for national security reasons.

JBPeebles Fri, 09/01/2017 - 14:45 Permalink

Don't think the issue is with a default. Like Greenspan said, the Fed can print up the money if need be. To be technical, the Bureau of Engraving and Printing can make the physical script. The Fed can buy bank assets with digital created money and no physical need trade hands.The issue is one of leverage. How leveraged are the banks? If they don't get interest payments on the debt they hold they can sell the Treasuries they have. This assumes the Fed will buy them. Would you buy a ten year paying 2%? Who other than the Fed can act as the buyer of last resort?The Fed's main purpose is becoming the stabilization of the markets. The budget crisis looming ahead is a crisis that only they can prevent. Their low rate policy makes the money available to borrow but political risk makes the creditworthiness of the government conditional upon the Fed's present and future willingness to intervene.The Fed's 10 year long intervention in the credit markets comes with a price--the government has become dependent on easy money to finance their growing deficits. In a classic example of capture, the government has become dependent upon the bankers over which they've traditionally exercised a regulatory role. Instead of limiting financial sector profits and normalizing rates, we have an atmosphere of ever growing debt because the Fed's enabling the ongoing purchase of government debt.Were the market for US government-issued debt truly a free market, the price of government borrowing would rise and the ever-expanding budgets be constrained. The interest burden associated with the debt would be cumulative and spending on things other than interest would become limited as more and more debt was issued.The enabling of huge deficits has been synonymous with the growth in the money supply. The derivatives bubble worsens the dire financial situation with the nation's balance sheet, enabled as it is with indirect Fed subsidies. The banks have partaken in the orgy of easy money under the quid pro quo that they keep buying the government's debt. Without sufficient interest to justify the risk of default, portfolio credit quality deteriorates. Just look at the flat yield curve--it's as if the longer term stuff is wildly overpriced/underyielding vis-a-vis the borrower's existing debt load which is already $20 trillion and growing fast. Logic is out the window and the bankers will get more cheap money to buy more US debt whatever the duration.Don't fear the illiquidity as the Fed can continue to make credit available in infinite quantities. The money will refill government coffers with a political compromise that forestalls default. Over the medium term, this concession to the status quo means more politically destabilization as inequity grows, andd an ever-bigger disconnect between the world's largest borrower and their true credit worthiness.

Dig Deeper1 Fri, 09/01/2017 - 16:44 Permalink

"Market reactions and market functioning might be comparatively stable at first, but the concern is of widespread panic and systemic market disruptions."  Why would there ever be panic?  All the participants in this game are fully aware of the backstops in place - if it can't happen, it won't.  Same story with equities.  These markets are so rigged and interdependant - not just regionally but globally - I can't imagine a scenario where the key players panic; the little guys, maybe but everyone has the playbook now.  Just turn the page.

NumbersUsa Fri, 09/01/2017 - 19:57 Permalink

By the way, George Soros's real name is Gyorgy Schwartz, another jew supremacist hiding behind a gentile name.SIGN THE PETITION HERE: from Thomas Jefferson (not THE TJ)"While I am glad to see there are people among the Jewish community who denounce the actions of the Zionist agenda, far more needs to be done publicly to spread the knowledge about these Satan worshiping atheists being humanities most dangerous enemy. We must declare war on the bankers who gave us the most destructive monetary system ever conceived. This system is designed to bankrupt world governments and their respective countries via compound interest that is impossible to repay. It has already transferred the vast majority of global wealthy to the bankers as governments struggling to pay off bank loans are forced to sell assets/utilities owned by the public.It is time to confiscate all bank stocks, liquid assets and the power of currency creation must be taken away from the banks and returned to the commonwealth of the people of each country and their official governments. This is the Achilles heel of all banks and where the Zionists have obtained ALL their power. All bank loans are to be cancelled globally. All immigration needs to cease immediately to defy the Zionist agenda to assimilate and dilute the purity of our racial nationalities. Our history needs to be re-written to expose the guilty for their lies and deception. Crime tribunals must be constructed to hold the Zionists/Mossad accountable for their belligerent, murderous and savage acts committed against humanity especially for their brutality and decimation of the Palestinian people."SIGN THE PETITION HERE: