Will this time be different? Congress prepares to dance with the debt ceiling
On Thursday morning, the US Treasury began taking extraordinary measures to avoid breaching the debt ceiling. These technical moves extend the time period during which Congress can decide to suspend or raise the debt ceiling, or the executive branch can implement some form of emergency override (which has historically never been used or needed). At this point, we’ve been here so many times that even these “extraordinary” measures have begun to feel “ordinary,” with the government relying on them over a dozen times since 1985.
For more on this topic, Eric Winograd, Director of Developed Market Economic Research, Alliance Bernstein, explains the backdrop and our view below.
The debate around the US debt ceiling is back again.
Last week, Treasury Secretary Janet Yellen announced that the US Treasury had hit the debt ceiling and would be forced to rely on extraordinary measures to meet its obligations until Congress passes legislation to increase it. While these measures are deemed “extraordinary,” the debt debate happens so often that it has started to feel ordinary.
What’s the debt ceiling?
As a refresher, the debt ceiling is a statutory rule that requires Congress to authorize the Treasury to borrow money. The debt limit itself has nothing to do with government spending plans, which are passed during the budgetary process. The fiscal 2023 budget was actually passed late last year. In essence, the debt ceiling is simply a vote to authorize the government to spend what it’s already committed to spending.
The ceiling was bumped up three times under the previous presidential administration without incident, but with Democrats controlling the White House and split control of the legislative branch, the ceiling becomes leverage for Congress to try to extract spending cuts from the administration if they don’t happen during the budgetary process.
Why would an impasse be disruptive?
The role of US government debt in the financial system is unique. Treasuries are used as hedges against investments perceived to be riskier. They’re also used as collateral in short-term trades that allow banks to fund themselves and maintain liquidity. Insurance companies, sovereigns, and other large borrowers hold massive amounts of Treasuries as reserves.
If Treasuries become perceived as riskier, it could upend parts of the financial system in unpredictable ways. This unpredictability is the foremost risk—the truth is, nobody really knows what a US sovereign default, even for a short period of time, would look like. It is an unprecedented event for which investors have no real hedge.
Of course, this isn’t the first time the debt ceiling has been a concern. The most obvious parallel to the current situation was the 2011 episode.
Hard to project the “Drop-Dead” date
It’s impossible to predict the “drop-dead” date—the moment when the government’s spending ability will be exhausted—too far ahead of time. The exact timing will depend on government revenue flows in the coming months. We estimate that the extraordinary measures may last into the third quarter. Markets seem to agree with that timetable—there are currently no disruptions priced into funding markets through the summer.
Unpredictability is the name of the game
In 2011, equity markets fell more than 15% as the deadline approached and investors became more alarmed. Paradoxically, Treasury yields fell—investors bought Treasuries even as they became more concerned about default and even as the risk of a sovereign downgrade rose. At the time, the combination of falling stocks and the belief that any default would be very short-term and much more likely to impact Treasury bills than longer-term bonds were enough to convince investors to buy Treasuries.
Will that happen again? It’s hard to say, and that unpredictability is what investors must keep in mind.
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