Treasury Traders Brace for Volatility With Debt-Limit Chaos Near

Short-term rates traders are girding for a bumpy road ahead, as the U.S. debt ceiling looks poised to return on Aug. 1 while Congress so far has no clear plan to increase it -- meaning federal government borrowing could soon get tricky.

Toward the top of the list of worries among traders: the U.S. is likely to reduce issuance of bills -- which are already in short supply as investors scramble for places to park cash -- because the Treasury Department needs to dramatically reduce its cash balance this month.

The debt ceiling was suspended for two years in July 2019. If Congress doesn’t increase that limit on U.S. borrowing or suspend it again, then Treasury will be forced to deploy extraordinary measures to keep paying its debts. Politicians have in the past decade used threats of not raising the debt ceiling to get concessions on other matters.

Bill rates have been hovering near low levels, dipping below zero at times, as Treasury already cut supply by more than $680 billion during the first half of 2021 to bring its cash balance down. There’s also a deluge of liquidity in the system due to the Federal Reserve’s asset purchases, inducing the central bank to lift key rates last month to help control its benchmark. Strategists will be eyeing Wednesday’s release of minutes from that gathering for potential new insights on officials’ views on that matter.

“Treasury bill paydowns will be a significant factor as Treasury tries to achieve its stated cash balance level,” said Jonathan Cohn, a strategist at Credit Suisse Group AG. Paydowns are when the government sells less debt than is maturing, thus reducing what’s in circulation. “I expect focus to start to shift toward drop-dead dates, bill curve dislocations, and other refrains common to the all-too-frequent debt limit showdowns.”

The Treasury said in May that it assumes the cash balance, known as the Treasury General Account, will amount to $450 billion at the end of the current debt-limit suspension period on July 31. Treasury’s cash balance was $784 billion as of July 1.

Treasury Traders Brace for Volatility With Debt-Limit Chaos Near

Treasury bills maturing through April 2022 are mostly yielding less than 0.05%. The heightened investor demand for bills was clear at Treasury’s sales this week of four- and eight-week bills. During the coming holiday-shortened week, bills are the only securities on the docket for Treasury auctions, with the government slated to sell 13- and 26-week bills on Tuesday and another round of four- and eight-week bills on Thursday.

Investors Gobble Up Treasury Bills as Supply Expected to Dwindle

House Speaker Nancy Pelosi said on Thursday that they were considering “all the options” with regard to the debt limit.

In a protracted 2013 debt-limit episode, Fitch Ratings put the U.S. rating on negative watch given the government’s failure then to raise its borrowing limit as the Treasury’s hard deadline neared. In 2011, a split House and Senate took the debt-limit debate down to the wire, prompting S&P Global Ratings to cut America’s sovereign credit grade for the first time.

“Democrats will likely be able to” increase or suspend the debt ceiling “even if they have to use the budget reconciliation process,” Merrill Matthews, resident scholar at the non-partisan Institute for Policy Innovation, said in a note. “But that could take a while -- and they don’t have much time, especially at the rate the federal government is currently blowing through money.”

Treasury Secretary Janet Yellen said last month before a Senate hearing that her department may exhaust emergency measures to avoid breaching the debt ceiling as soon as August unless Congress acts to avert a potential default that would be “catastrophic.” However, market analysts have said the administration can avoid hitting it until at least October.

What to Watch

  • Financial markets are closed Monday for Independence Day
  • The economic calendar
    • July 6: Markit U.S. services and composite PMIs; ISM services index
    • July 7: MBA mortgage applications; JOLTS job openings
    • July 8: Jobless claims; Langer consumer comfort; consumer credit
    • July 9: Bloomberg July U.S. economic survey; Wholesale trade and inventories
  • The Fed calendar:
    • July 7: FOMC meeting minutes; Atlanta Fed’s Raphael Bostic
  • The auction calendar:
    • July 6: 13-, 26-week bills
    • July 8: 4-, 8-week bills

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