Beware the Debt Ceiling
Euphoria has been pervasive in the stock market since the election. But investors seem to be overlooking the risk of a U.S. government default resulting from a failure by Congress to raise the debt ceiling. The possibility is greater than anyone seems to realize, even with a supposedly unified government.
In particular, the markets seem to be ignoring two vital numbers, which together could have profound consequences for global markets: 218 and $189 billion. In order to raise or suspend the debt ceiling (which will technically be reinstated on March 16), 218 votes are needed in the House of Representatives. The Treasury’s cash balance will need to last until this happens, or the U.S. will default.
The opening cash balance this month was $189 billion, and Treasury is burning an average of $2 billion per day – with the ability to issue new debt. Net redemptions of existing debt not held by the government are running north of $100 billion a month. Treasury Secretary Steven Mnuchin has acknowledged the coming deadline, encouraging Congress last week to raise the limit immediately.
Reaching 218 votes in favor of raising or suspending the debt ceiling might be harder than in any previous fiscal showdown. President Donald Trump almost certainly wants to raise the ceiling, but he may not have the votes. While Republicans control 237 seats in the House, the Tea Party wing of the party has in the past has steadfastly refused to go along with increases.
The Republican Party is already facing a revolt on its right flank over its failure to offer a clean repeal of the Affordable Care Act. Many members of this resistance constitute the ultra-right “Freedom Caucus,” which was willing to stand its ground during previous debt ceiling showdowns. The Freedom Caucus has 29 members, which means there might be only 208 votes to raise the ceiling. (It’s interesting to recall that, in 2013, President Trump himself tweeted that he was “embarrassed” that Republicans had voted to extend the ceiling.)
It may be unrealistic to expect Democrats to save the day – at least initially. House Democrats may be more than happy to sit back and watch Republicans fight among themselves. If the Democrats eventually ride to the rescue, it probably won't be until after a period of Republican-on-Republican violence.
Nobody wants the Treasury to reach the point where it has to prioritize payment of interest over other obligations – a threshold where creditworthiness and market confidence will have begun to retreat. The bond market already seems to be reacting to this possibility, sending yields higher and prices lower, even as the S&P/Dow/Nasdaq have been on a tear and are showing scant concern over the potential turmoil.
In an ideal world, all sides would come together and not play politics with the debt ceiling again. Clearly that’s not the world in which we live. America’s partisan divide may now be so wide that a default will occur. That isn’t my base case scenario, but we will probably come down to the wire.
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