Stocks and short term Treasury bills rallied Friday as U.S. debt-ceiling talks in Congress showed promise of reaching an agreement on the government’s borrowing limit during the Memorial Day holiday weekend.
The Dow Jones Industrial Average
snapped a five-day losing streak, but still was down about 0.2% on the year, according to FactSet. The S&P 500 index
advanced 1.3% Friday, gaining 9.5% for the year. The Nasdaq Composite Index
gained 2.2% Friday and 24% for the year so far.
The protracted fight in Congress over the debt limit prompted Fitch Ratings late Wednesday to place the U.S.’s Triple-A credit rating on “ratings watch negative” for debt issuance, pointing to “brinkmanship” over the debt ceiling.
Fears around the debt-ceiling have been reflected in Treasury bill prices, especially those maturing around June 1, or the “X-date,” when Treasury Secretary Janet Yellen initially was expecting the U.S. to no longer have enough funds to pay all its bills, without an agreement in Washington. Before rallying Friday, those securities briefly touched yields north of 7% Wednesday, or roughly what higher-quality junk bonds fetch.
“Which is insane,” said Judith Raneri, a senior portfolio manager at the Gabelli U.S. Treasury Money Market Fund. “I’m in the camp that truly feels they are going to reach a decision,” she said of the debt-ceiling standoff. “Each party is going to have to give a little. Then we can move on.”
But before then, here are three things to know about markets and the debt-ceiling as the Memorial Day weekend draws closer:
1. Drop-dead date
President Joe Biden’s team and House Speaker Kevin McCarthy’s deputies are nearing a deal to raise the current $31.4 trillion debt-limit, but getting the deal through Congress quickly could prove tricky.
Yields on 1-month Treasury bills
were lower, near 5.54% on Friday, but still up from around 0.50% a year ago, according to FactSet.
That compares with a 1-year Treasury yield
of 5.24% and 10-year Treasury yield
of 3.80%. Typically, bond yields are higher on longer-dated debt due, since it can be harder to anticipated risks of a default further out into the future.
In 2011, it took two days after a debt-ceiling deal was reached for Congress to pass the law raising the debt ceiling. Yellen said Friday that Congress must raise or suspend the U.S. debt ceiling by June 5 or risk a default, extending a previous deadline by a few days.
Those dates aren’t set in stone. Goldman Sachs economists said U.S. Treasury funds will be exhausted by June 9, without a deal on the U.S. borrowing limit, which they view as likely. However, some analysts warned talks could drag out until the Federal Reserve’s next rate-setting meeting from June 13-14.
While a full-blown U.S. government default could spark mayhem in global financial markets, even a brief default could tip an already fragile economy into a mild recession.
2. Lessons from 1979 payment blip
There may be a precedent for how the Treasury might handle any missed interest payments of maturing Treasury bills in the event of a technical default, according to the Wells Fargo Investment Institute.
A technical glitch in 1979 caused a “blip” in payment processing that caused some delays in interest payments on some Treasury bills. Legal battles and new legislation followed, providing a potential pathway to making investors whole for any delayed payments in June, strategist said in a client note Wednesday.
Raneri at Gabelli Funds said she’s been limiting exposure to Treasury bills with a maturity around the X-date, while favoring two-month and three-month bill auctions. “I think a lot of money-market funds are avoiding the short end of the curve because of this concern.”
3. U.S. still has low interest payments
The U.S. Treasury hit its current borrowing limit in January, and has been running down its cash account at the Federal Reserve, with Fitch Ratings pegging its balance at around $70 billion as of Wednesday.
While a new debt limit would mean borrowing from the public at much higher rates than in the past few years, Oxford Economic pegged federal interest payments as a share of gross domestic product at 1.9% in 2022, lower than the 3% in the early 1990s, “even though the level of debt is significantly higher.”
The Treasury is expected to release a deluge of Treasury bill issuance once a deal on the borrowing limit is reached. Analysts expect that rates would need to exceed the roughly 5% rate offered by the Federal Reserve’s popular reverse repo facility to entice funds marked there overnight into shorter-term Treasury debt.
Ryan Sweet, chief U.S. economist at Oxford Economics, said “higher rates this year will increase interest payments as a share of GDP, but that share won’t approach the tipping point where the government is unable to finance its debt, and higher interest payments aren’t a reason to not raise the debt ceiling,” in a Wednesday client note.