By Joy Wiltermuth
In 2011, it took two days for a US weekend debt ceiling agreement to become law
Stocks and short-term Treasuries rallied on Friday as U.S. debt ceiling talks in Congress looked promising to reach an agreement on the government’s borrowing limit over Memorial Day weekend. .
The Dow Jones Industrial Average ended a five-day losing streak but was still down about 0.2% on the year, according to FactSet. The S&P 500 index advanced 1.3% on Friday, gaining 9.5% for the year. The Nasdaq Composite Index gained 2.2% on Friday and 24% for the year so far.
The protracted fight in Congress over the debt ceiling prompted Fitch Ratings on Wednesday night to place the U.S. Triple-A credit rating on “negative ratings watch” for the debt issuance, indicating a “failure on the debt ceiling.
Fears about the debt ceiling were reflected in the prices of Treasuries, especially those maturing around June 1, or “X date”, when Treasury Secretary Janet Yellen initially expected that the United States no longer has enough funds to pay all its bills. , without agreement in Washington. Before rallying on Friday, these stocks briefly touched yields north of 7% on Wednesday, roughly what high-quality junk bonds are yielding.
“Which is insane,” said Judith Raneri, senior portfolio manager at Gabelli US Treasury Money Market Fund. “I’m on the side that really feels they’re going to make a decision,” she said of the debt ceiling standoff. “Each part is going to have to give a little bit. Then we can move on.”
But before that, here are three things to know about the markets and the debt ceiling heading into Memorial Day weekend:
1. Deadline for filing
President Joe Biden’s team and House Speaker Kevin McCarthy’s aides are close to reaching a deal to raise the current $31.4 trillion debt ceiling, but push the deal through quickly by Congress could be tricky.
Yields on 1-month BX:TMUBMUSD01M Treasury bills were down nearly 5.54% on Friday, but still up from around 0.50% a year ago, according to FactSet.
This compares to a 1-year Treasury yield BX:TMUBMUSD01Y of 5.24% and a 10-year Treasury yield BX:TMUBMUSD10Y of 3.80%. Generally, bond yields are higher on longer-term debt, as it can be more difficult to anticipate longer-term default risks.
In 2011, it took two days after a debt ceiling agreement was reached for Congress to pass legislation increasing the debt ceiling. Yellen said Friday that Congress must raise or suspend the U.S. debt ceiling by June 5 or risk a default, extending a previous deadline by a few days.
These dates are not set in stone. Goldman Sachs economists have said US Treasury funds will run out by June 9 without an agreement on the US borrowing limit, which they see as likely. However, some analysts have warned that the talks could drag on until the next Federal Reserve rate-setting meeting on June 13-14.
While a widespread US government default could wreak havoc on global financial markets, even a brief default could tip an already fragile economy into a mild recession.
Read: What happens if the debt ceiling is not raised? “If there was ever a time for a rainy day fund, this is it.”
2. Lessons learned from the 1979 payment error
According to the Wells Fargo Investment Institute, there may be precedent for how the Treasury could handle missed interest payments on maturing Treasury bills in the event of a technical default.
A technical glitch in 1979 caused a “blowout” in payment processing that led to delays in interest payments on some Treasury bills. Legal battles and new legislation followed, providing a potential avenue to make investors whole for any late payments in June, the strategist said in a client note on Wednesday.
Gabelli Funds’ Raneri said she was limiting exposure to Treasury bills with maturity around date X, while favoring two- and three-month bill auctions. “I think a lot of money market funds avoid the short end of the curve because of this concern.”
Read also: How will the Fed react to the breach of the debt ceiling? Here are some games in the playbook
3. The United States still has low interest payments
The US Treasury reached its current borrowing limit in January and depleted its cash account at the Federal Reserve, with Fitch Ratings pegging its balance at around $70 billion on Wednesday.
While a new debt limit would mean borrowing from the public at much higher rates than in recent years, Oxford Economic has pegged federal interest payments as a share of gross domestic product at 1.9% in 2022, lower than the 3% of the early 1990s. , “even if the level of indebtedness is significantly higher”.
The Treasury is expected to issue a deluge of Treasury bond issuances once an agreement on the borrowing limit is reached. Analysts expect rates to rise above the rate of about 5% offered by the Federal Reserve’s popular reverse repo facility to lure funds marked overnight into shorter-term Treasury debt.
Read: Debt ceiling deal will spark new worry: Who will buy the deluge of Treasuries?
Ryan Sweet, chief US economist at Oxford Economics, said “higher rates this year will increase interest payments as a percentage of GDP, but that share won’t approach the tipping point where the government is unable to finance its debt and higher interest payments are no reason not to raise the debt ceiling,” in a Wednesday client note.
-Joy Wiltermuth
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05-26-23 1714ET
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