The Debt Ceiling Is Coming Back and Some Treasury Bills Are About to Get Squeezedby
Rallying point of deficit hawks set to become Trump’s problem
U.S. must cut cash holdings to less than one day’s outlays
One of the first tests of the Trump administration will be what to do about the statutory limit on the nation’s debt, a favorite cudgel of anti-deficit Republicans, including Budget Director nominee Mick Mulvaney. Money market rates are already signaling disruptions going into the March 15 deadline.
Because of a deal struck to avoid a debt-ceiling showdown during the election season, the Treasury Department will have to cut its cash balance from about $370 billion to $23 billion, the previous level when the limit was suspended in November 2015. To put that in perspective, the Treasury estimates it needs to maintain a weekly cash cushion of about $150 billion just to pay its bills.
Treasury has already started cutting back on the sales of short-term bills, resulting in about $93 billion fewer bills outstanding since the start of December. This has been the strategy employed in the past with little disruption to the markets. Except this time around there has been a flood of money into government money-market funds as a result of Securities and Exchange Commission reforms that went into effect in October.
At the same time, the reduction in bills is likely to push yields through the bottom of the Federal Reserve’s 50 basis point target for short-term rates, according to Thomas Simons, a senior economist at Jefferies LLC in New York. Treasury bill rates for tenors out to four months are trading on top of the Fed’s floor, while yields in the six- to 12-month sector have fallen 6 to 10 basis points.
“In the previous episode two years ago, Treasury had to do the same thing, but the cash balance was only $200 billion and Treasury bill yields fell by two to six basis points,” said Jay Barry, an analyst at JPMorgan Chase & Co. “Now we expect a move that’s double that.”
The debt ceiling was put in place almost 100 years ago as a way of simplifying the nation’s financing process, so the Treasury didn’t need to go to Congress every time to get approval to borrow. Raising the debt limit doesn’t authorize new spending, it just allows the government to pay bills already incurred.
Even though debt-limit standoffs have been around since the Eisenhower administration, they were taken to a new height in the 1990s, when House Speaker and now Trump adviser Newt Gingrich threatened the possibility of default unless Republican tax and budget demands were met.
There are consequences. The uncertainty generated from the 2011 impasse contributed to S&P Global Ratings’s decision to downgrade the U.S. Higher borrowing costs ripple through to consumers and everyone from contractors to veterans to social-security recipients are at risk of not being paid.
While two Fed rate increases in little more than a year have pushed yields higher, there’s an expectation that the squeeze will become more pronounced in mid- to late-February, since that’s when the bulk of tax refunds are paid and Treasury tends to issue more short-term securities to offset the outlays.
In a November letter to Treasury Secretary Jacob Lew from the Treasury Borrowing Advisory Committee, a group of professionals from investment funds and banks that offers guidance to department officials, one member estimated that the T-bill share of marketable debt would “shrink appreciably” and yields would drop as much as 20 basis points.
Once the debt ceiling is reinstated, Treasury will have a second component to address: the so-called drop-dead date, the last possible deadline where investors start dumping bills maturing around the deadline and the government can no longer make payments. That could send yields shooting higher.
Republican Party control of both Congress and the White House should suggest an easier path this year. But that may prove more difficult than expected given that lawmakers including Mulvaney were more than willing to consider default as recently as last year to force their anti-deficit agendas. Mulvaney’s office didn’t respond to a request for comment on the debt ceiling.
Lew has gone so far as to suggest doing away with the debt ceiling altogether as the mechanism has “outlived its usefulness,” according to an essay he published in the January edition of the Harvard Journal on Legislation.
“The existence of the debt limit is hard to defend; it is a purely political construct,” Lew said. “No longer a tool for simplifying the borrowing process, the debt limit has morphed into a weapon that irresponsible actors in Congress can wield against our economic well-being.”
Now it’s Donald Trump’s problem.