The ongoing stalemate in Washington is proving to be a financial burden for investors, and it appears that the costs may continue to rise.
The U.S. Treasury market is renowned for its size and liquidity, attracting a wide range of investors, from regular citizens to foreign governments like China and Japan, who seek to purchase federal government debt. However, the market has experienced significant volatility recently due to the Federal Reserve’s decision to increase interest rates to levels not seen since the disco era. As a result, yields across various maturities have become inverted, indicating that investors are receiving lower returns for owning a 10-year bond compared to a six-month bill. This inversion typically signals an imminent recession, as the economy is deemed riskier in the near term than in the long term.
The Treasury market is currently experiencing anxiety about the actions Washington may take to ensure the government can still meet its debt obligations. In January, the federal government hit its maximum borrowing capacity of $31.4 trillion, known as the debt ceiling, which restricts its ability to acquire more funds to cover its outstanding bills. Despite this, the Treasury Department is employing unconventional methods to sustain its operations, such as reducing payments to government retirement plans, to extend the timeline.
Although the exact timing is subject to discussion, it is widely accepted that the measures currently in place to sustain the economy will eventually fall short. The projected time frame for this occurrence falls within the range of June to September, but the uncertainty lies in the amount of revenue the government will receive from taxes and other sources. Ultimately, the estimated dates are based on predictions that may not necessarily align with reality.
Holders of government debt may feel uneasy about the possibility of a default, which has never occurred before, or even the delay or prioritization of payments, which could result in some individuals receiving payments while others do not, or not as promptly. This could leave bondholders in a precarious position. Alternatively, credit-rating agencies may downgrade the U.S. government’s credit rating, resulting in increased future borrowing costs.
On Wednesday, House Speaker Kevin McCarthy achieved a narrow victory by passing a bill that proposes to extend the debt limit for a year. The bill, in exchange for the extension, includes a set of spending cuts and some adjustments to President Joe Biden’s policy agenda. This event marks the beginning of a significant development.
After successfully passing the bill to lift the debt limit, McCarthy stated that the House of Representatives had fulfilled its duty. However, the situation now gets interesting as the Senate has deemed the bill unfeasible, and the White House has released a statement declaring that President Biden will not permit the burden of tax cuts for the wealthiest individuals to fall on middle-class and working families, as the bill proposes. The President has also emphasized that this bill has no prospects of being enacted into law.
The bond market’s sentiment can be gauged through the performance of the one-month Treasury bill, a short-term financial instrument widely used for parking cash that may be required for investments or for withdrawals from money-market funds and other short-term accounts.
At the end of March, the one-month bill yielded 4.704%, but as of Thursday, it has declined to 3.795%. In contrast, the three-month Treasury yield has increased from 4.8% to 5.14% by the same period.
Investors, including money-market funds and individual investors, are making similar tradeoffs and prefer to purchase bills that mature before the D-Day for the debt ceiling. This is the easiest decision, according to Andy Constan, who spent more than three decades at top investment firms and currently operates Damped Spring Advisors, a macroeconomic research firm, as he tweeted in mid-April.
Wells Fargo economists have revised their analysis of the ongoing debt ceiling debate and now predict that the “x” date, or the deadline for the U.S. Treasury to raise the borrowing limit, is likely to occur in early August. Specifically, they believe that the first three days of August are the most probable timeframe for this event.
One factor contributing to the uncertainty is the lower-than-expected tax revenues that have been collected, despite a strong performance in 2022. Additionally, the balances in the Treasury’s bank account at the Federal Reserve have been fluctuating recently. These balances reached nearly $1 trillion in May 2022 but dropped to less than $90 billion in March. However, they have since risen to $265 billion as tax payments for 2023 are processed.
Many experts anticipate that both parties will engage in a political tug-of-war leading up to the “x” deadline, a familiar pattern from previous years. However, this approach comes at a significant cost, as evidenced by the 2011 showdown. In that instance, the debt ceiling was ultimately raised in exchange for future budget cuts, but not before a tumultuous period that saw a sharp sell-off in stocks, a 17% decline in the S&P 500, and rising bond yields. Reports later estimated that delaying the increase cost the government an additional $1.3 billion in borrowing expenses.
At present, market observers seem to be only slightly worried about the likelihood of a default, as they have witnessed similar situations unfold in Congress over time. As the deadline approaches and the language becomes more heated, the issue will mostly be a psychological one, according to Gene Goldman, Cetera Financial Group’s chief investment officer. It will resemble the 2011 scenario, where everyone waited until the final moment.
The current political climate comes with a caveat: a group of influential members from both major political parties are no longer dependent on their party leaders and are more inclined to voice their opinions on social media and cable TV platforms, where their voters tend to congregate.
This trend is particularly evident now as the two major contenders for the 2024 presidential election, Joe Biden and Donald Trump, are not very popular with the general public. While Democrats experienced an unprecedented run of legislative achievements during their first two years of holding the presidency and Congress, the current situation has changed with the House now being controlled by Republicans, altering the dynamics of the political landscape.
Source of Story ; CNBC News, US News, U.S. Department of Treasury