The U.S. federal government reached its debt limit - Commonly called the “debt ceiling”, the debt limit is the maximum amount of debt that the U.S. Department of the Treasury can issue to the public or to other federal agencies. The Treasury announced that it reached the debt limit - on January 19, 2023 and has since utilized cash balances and “extraordinary measures” as a means to prevent the U.S. from defaulting on its payment obligations.
The precise timing of the “x-date”, when the Treasury will exhaust its available cash and extraordinary measures, is still unclear. Treasury secretary Janet Yellen said on May 1 that “…our best estimate is that we will be unable to continue to satisfy all of the government’s obligations by early June, and potentially as early as June 1…the actual date that the Treasury exhausts extraordinary measures could be a number of weeks later than these estimates."
Also on May 1, the Congressional Budget Office (CBO) stated that “we now estimate that there is a significantly greater risk that the Treasury will run out of funds in early June…the projected exhaustion date remains uncertain, however, because the timing and amount of revenue collections and outlays over the coming weeks are difficult to predict.”
Prior to the May 1 announcement, market estimates for the “x-date” were for the end of July and beginning of August. The belief was that if treasury cash balances lasted until June 15th corporate tax receipts could replenish cash balances through June 30th. At that point, the treasury would be able to make use of additional extraordinary measures, which would push the x-date out about another month from there. However, given Yellen pulled forward her x-date estimate by 4 days and that tax receipts have come in even less than some estimated, market estimates are also beginning to get pulled forward acknowledging the greater risk of an early June x-date.
As the market begins to position around the potential of an earlier x-date, there has been a notable cheapening of June Treasury Bill maturities, with particular movement in June 1 to June 15 Bills. We’ll continue to see a kink in the curve around those treasuries maturing nearest to the most recent consensus x-date estimate until there is a resolution. The legislative process to raise or re-suspend the debt limit has not been, and will not be, swift. Congressional leaders are scheduled to meet with President Biden on May 9 to discuss the debt limit, but a resolution may not be reached until very close to the x-date.
Prior debt limit episodes have never resulted in a default by the U.S. Treasury, but the uncertainty associated with the politics can induce both market volatility and client anxiety. While not our base case scenario, it’s important to note that if a political resolution was not reached in time and payments were ultimately delayed on a Treasury security, the default would be limited to the specific maturity date/coupon date (no cross default). The effected bonds would remain on Fedwire and continue to trade in the secondary market (assuming the Treasury notified markets one day prior to the delay).
Frequently Asked Questions
Is there a possibility of a short-term resolution? With limited time until June 1, the U.S. Congress could agree to suspend the debt limit for a short period – perhaps until September 30 to coincide with budgetary negotiations, or until the end of July before the August recess.
Is there a risk of another downgrade of the U.S. Treasury’s credit rating? While we do not anticipate a downgrade or watch listing, S&P has previously downgraded the U.S. Treasury’s credit rating by one notch to AA+ in 2011. However, a downgrade would likely have no impact on the ability of money market funds to purchase or hold U.S. Treasury securities.
Would the Treasury prioritize payments to meet interest and principal obligations on U.S. Treasury bonds? Yellen has publicly pushed back on prioritization, stating that the US Treasury’s systems were built to pay all bills on time and not prioritize one payment over another. However, we know that the topic has been discussed at both the Federal Reserve and the Treasury, and it seems likely that prioritization would at least be considered in the event the debt limit is breached.
Are defaulted U.S. Treasury securities liquid? If the Treasury announces its intention to postpone a payment date in advance (the day before the payment is due), the security will remain in Fedwire, and would therefore still be transferable.
Could money market funds hold defaulted U.S. Treasury securities? Neither Rule 2a-7, nor any of the AAA money market fund ratings criteria explicitly require immediate liquidation upon default.
What about repo collateral and U.S. Treasuries in default? Defaulted Treasury securities would remain eligible as collateral if maturity dates were extended in a timely manner and the bonds remained on Fedwire. Collateral is re-priced daily so counterparties would be required to “top-up” collateral baskets with additional bonds to maintain required haircuts (assuming price declines on the effected securities).
Does J.P. Morgan Global Liquidity have a playbook for a default scenario? A detailed playbook has been developed at the Asset Management business level to plan for various debt limit scenarios including the specific impacts to Global Liquidity. This framework has been in place for several years given the recurring nature of the debt ceiling issue.