Congressional Dispute Highlights Risk of US Default Deadline

As the fight over who will become the next House of Representatives speaker drags on, investors are growing increasingly concerned that lawmakers will not be able to agree on a plan to avoid breaching the US government's statutory borrowing limit this year.

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If the debt ceiling is not lifted or suspended in time, it could trigger a technical default by the US or encourage credit assessors to downgrade the country’s rating. This is something Standard & Poor’s did in the wake of a previous debt-cap standoff in 2011. Given the potential for these kinds of events to upset global financial markets, traders are analyzing when that key date might be.

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The drop-dead date, as it is known, is estimated by a number of analysts to be some time in the third quarter of 2023. In an environment where political leaders can reach an actionable agreement, that should leave plenty of time. However, the failure of the House to even elect a speaker suggests that any agreement will be hard-fought. Jefferies LLC economist Thomas Simons has said that the current deadlock in the House "almost completely eliminates any chance of it being handled smoothly, which was already pretty low."

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The debt ceiling is already causing turmoil in markets, especially in the short-term fixed-income markets, where securities with shorter maturities are more vulnerable to default. While Treasury bills are not currently showing any concerns about the debt limit, eventually investors will start to avoid the most vulnerable maturities.
This is because if the US reaches its borrowing limit, debt that matures soon after might not be repaid on time. Investors in those securities would then demand higher interest rates to compensate for the risk. Longer-term bills usually have higher rates than shorter-term ones, and that is still the case at the moment. However, that could change once the market starts to come to a consensus about when the government is likely to reach its borrowing limit.

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The House GOP's recent mutiny signals that there may be trouble ahead in terms of defusing the debt crisis. This is a story that is definitely worth keeping an eye on.
The outgoing Congress, which was controlled by the Democratic Party, chose not to address the issue during its lame duck session. This period occurs between the November election of new members and the seating of them in January. Instead, the Congress was focused on other legislative priorities for that limited timeframe.

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The new House is majority Republican, which stands in opposition to President Joe Biden. Analysts had already anticipated that finding a resolution on the debt limit might be difficult under those circumstances. But now they’re girding for a messier outcome amid upheaval that’s seen the GOP’s Kevin McCarthy fail to secure enough votes for the speakership through numerous ballots.

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The government is officially $78 billion away from reaching the $31.4 trillion statutory limit. However, the Treasury has historically used various extraordinary measures to avoid exceeding the cap as soon as it might otherwise. These measures include reducing the amount of Treasury bills it issues, spending down cash it keeps at the central bank, and suspending payments to government trusts.

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The final cutoff date for the measures will be determined by when and how they are enacted, as well as the flow of government outlays and receipts. The influx of tax money in April is likely to provide a cushion, though with the economic situation and asset values having deteriorated, flows are not expected to be as bountiful last year. On the flipside, tax refund payments have the potential to accelerate outflows.

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The size of bill auctions is a factor that can cause swings in the market. The Treasury started shrinking these in late 2022, which further delayed the use of its accounting gimmicks to prolong its borrowing authority. However, it's not a straight path and there is a limit to how low the sale sizes can go. The Treasury still needs to roll over existing debts and fund government payments.

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Strategists from Bank of America Corp., UBS Securities and Wrightson ICAP have identified a date sometime in the third quarter when they believe the market will drop.
The US has come close to the precipice before, in 2011. A standoff between the Democratic administration of Barack Obama and the Republican leadership led S&P to strip the US of its top credit rating. The tradeoff then was for the ceiling to be raised in exchange for future spending cuts. There's a chance that's how it will play out again.

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This time could be different, however. Many of the same Republican Party members who are currently preventing McCarthy from becoming Speaker of the House are also eager to fight over the debt limit, demanding that party leaders use the threat of default as leverage to force deep spending cuts. If McCarthy makes concessions in order to become Speaker, it could limit his ability to push through debt-cap legislation.

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Biden and other Democratic leaders have rejected giving in to what they disparage as "hostage taking" with the US economy. They believe that this would be detrimental to the country and its people.

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Amid the standstill, California Democrat Brad Sherman on Wednesday floated a potential deal that would trade Democratic votes to make McCarthy the speaker in return for rules aimed at preventing a US government shutdown or a debt-limit crisis. Sherman's proposal would give Democrats some control over the House agenda in exchange for their support for McCarthy as speaker. It's not clear whether Sherman's proposal will gain any traction, but it's an interesting idea that could help break the impasse in the House.

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In November, Blake Gwinn, head of US interest rate strategy at RBC Capital Markets, predicted that the GOP's control of the House would lead to a messy situation. Gwinn's prediction has not changed in the intervening months.