US Debt Ceiling
Fundamentals Update as at 6 February 2014 by Lorenzo Beriozza
The forecast is the Treasury will exhaust extraordinary manoeuvres on February 28, the settlement date of the end-of-month coupon auctions. The exhaustion of the federal government’s cash balance is likely to occur on the next business date, March 3, and thus the Treasury will not be able to pay the full amount of Social Security and tax refund payments on that date. The first Treasury debt vulnerable to default is the March 6 bills.
Congress at that point will pass a debt limit bill before deadline. The focus in passing a debt limit bill is on the House of Representatives. It appears that the House Republicans were not able to agree on a united plan to deal with the debt limit at a conference last week. Thus the most likely course of action is for the House Republican leadership to allow a clean debt limit vote, similar to how the omnibus spending bill was passed in December.
The most common estimates of the debt limit dates are unusually uncertain. It is reasonable to assume the Treasury’s assumption that only $200 billion of extraordinary manoeuvres are available. Furthermore, the pace of refunds will occur at the same rate as last year, but given that this is the first tax year for exceptionally large changes in marginal tax rates, and given the large capital gains expected from the stock market rally, the uncertainty around refund flows is high.
There is some chance that the debt limit date will be on February 27, which is the maturity date for Treasury bills, and that only the rollover amounts of the end of month coupon auction will be allowed. In this scenario, the cash balance could be exhausted on February 28, with the Treasury unable to pay the full amount of Medicare, military pay, and possibly even interest payments. The scope for delaying to a later date is limited, given the large federal expenses around February 28 and March 3.
If Congress does not reach a deal by February 20, it is likely there will be an announcement to postpone the end-of-month auctions (for the 2y, 5y, 7y notes and the 2y FRN). In the scenario, where a deal is not reached by February 25, the auctions will be postponed, with the Treasury preparing market participants to conduct multiple auctions on the same day.
A further cheapening of the March maturity is also to be factored in T-bills and term repo rates as the debt limit deadline approaches without a resolution. Bill liquidity deteriorated significantly in October, which was exacerbated by net outflows of over $55 billion from government MMFs in the two weeks prior to the October 17 drop dead date. A deterioration in market conditions is to be expected again, though it is worth noting the October episode was worsened by the government shutdown, a factor not present this time. In addition, the Treasury will be ramping up bill issuance to fund tax refunds, which could exacerbate the rise in yields caused by the debt limit.
Source: Bank of America Merrill Lynch