The standoff between the White House and Congress over raising the US debt ceiling has been the talk of the town for months. Now that the government has reached an agreement, savvy investors will be on the hunt for opportunities—and we think there will be some attractive ones.
After breaching the $31.4 trillion statutory debt ceiling in January, the US Department of the Treasury resorted to “extraordinary measures” to meet its obligations and keep the federal government solvent. That has meant running its Treasury General Account—essentially the government’s checking account—in a tight range and aggressively issuing and paying down T-bills, depending on short-term cash needs.
But the House of Representatives on Wednesday voted to suspend the country’s debt ceiling for two years, and the bill is expected to win approval in the Senate and be signed into law by President Biden in short order. This would neutralize—for now—the risk of an “accidental” default. Perhaps more importantly for investors, it clears the way for the Treasury to replenish its checking account to $500 billion (Display) and make good on a backlog of delayed payments.
This may result in a surge of T-bill issuance to increase cash buffers and fund deficits; Wall Street expects anywhere from $1 trillion to $1.5 trillion of new supply by year-end. Indeed, the T-bill curve started cheapening in the days leading up to the X-date of June 5—the day the Treasury is expected to run out of cash to pay its bills—in anticipation of a deal.
The resulting decline in T-bill prices and rise in yields should provide an attractive buying opportunity for investors at the front end of the Treasury curve, particularly relative to overnight index swaps. Possible increases in longer-dated Treasury issuance and the Federal Reserve’s ongoing efforts to shrink its balance sheet may add to overall supply, though that may be tempered somewhat by excess cash in the system tied to the Fed’s reverse repurchase operations.
Increased supply may put pressure on short-term funding markets as repo and commercial paper rates begin to compete with higher T-bill rates, forcing dealers to pay up to finance additional inventory. In other words, for a time there will likely be too much collateral and not enough available funding. But while we think investors should expect some temporary dislocations, we don’t anticipate liquidity to disappear altogether.
Will this agreement help to avert future clashes over the US debt ceiling? That’s a lot harder to say. The latest standoff was hardly the first market disruption to emerge from a disagreement in Washington. The best investors can do, in our view, is to stay nimble and be prepared to take advantage of the opportunities that these disruptions can create.