The Impact of the Debt Ceiling on Treasury Bills and Cash Management

US Treasury Department
Economy
Treasure Investment Team
|
May 18, 2023

Sometimes Washington can feel like a scene from Groundhog Day, especially when we're talking about the debt ceiling once again. However, reality is often stranger than fiction, and if you own Treasury Bills, this politically volatile environment might have caught your attention. At Treasure, we've been hearing from clients who are looking for our expert insight into how we're thinking about this situation and our predictions and advice. But first, let's review the background and potential impact of the ongoing negotiations across Congress.

Explaining the Debt Ceiling

In plain terms, the debt ceiling is a legal limit set by the U.S. Congress on the total amount of debt that the federal government can accumulate. When the government reaches the debt ceiling, it can no longer borrow money and must find other ways to finance its spending. These often include actions like cutting programs or raising taxes. As we have seen in the past, the debt ceiling often becomes a point of political contention.

The U.S. reached its ceiling a few months ago on Thursday, January 19. Once the debt limit was reached, the Treasury Department began implementing extraordinary measures to prevent a default. It is currently expected that the government will exhaust its cash and the extraordinary measures before early June. After that, there is “considerable uncertainty” around the exact date when the limit will be reached. This date is often referred to as the “X” date in the media.

Debt Ceiling: A Brief History

The debt ceiling has its origins in the early 20th century when the US government began to issue debt to finance its growing budget deficit. In 1917, Congress passed the Second Liberty Bond Act, which established a limit on the amount of debt that could be issued under the act. This was the first time a legal limit on federal debt was established. The debt limit was raised several times over the following decades, and by the 1940s, it had become a routine part of the budget process. Despite this routine, the debt limit rarely became a contentious issue until the 1970s when the government began to run large budget deficits. Since then, raising the debt ceiling has become a regular political battle. Since 2000, the debt ceiling has been raised 18 times, with the shortest period between increases being just a few months in 2011 and 2013 respectively.

2011 might have marked the most contentious negotiation. The months-long back and forth culminated in August with a sharp decline in equities, as the U.S. rating was downgraded by Standard and Poors due to the heightened political risk. In 2013, the government also went into partial shutdown, with 800,000 government employees being put on temporary leave. But as the chart below shows, the impact on Treasury Bills was also muted (a change of 0.4% of yield which is less than 0.06% change on a price of a 2 month T-Bill) and even more importantly completely temporary.

Chart from: Take it to the Limit: The Debt Ceiling, Political Brinkmanship, and Treasury Yields. (link)

Treasure’s Recommendation: Stay the Course

Given the political situation, a T-bill holder may (mistakenly) think selling their securities and moving funds into a bank is the safe or optimal move. Unfortunately, this doesn't shelter against the risk of a government default as banks are one of the largest holders of T-Bills and they would also be dramatically affected by a US default. And as we've seen with the recent banking crises, holding funds in bank accounts in amounts above the FDIC limit is a risky choice indeed. (Custodial accounts are the way to go!)

Perhaps more importantly, at Treasure, we think the larger picture is that here is an extremely low likelihood of a US default. While negotiations may draw out over the next few weeks, ultimately Congress (and the entire financial system) is highly incentivized to avoid the widespread ripple effects that would be brought on by a default. There is a reason that the US has never defaulted!

And if a default were to occur, which again we believe highly unlikely, we are confident it would be resolved within a matter of days and impact on Treasuries would be little more than a temporary blip. As such, we are recommending to clients who hold T-Bills to maintain their current allocations (or even increase them if they want to be opportunistic). And we are putting our money where our mouth is – this is the same strategy we are using with our own funds invested through the Treasure platform. For clients who do want to make adjustments to their T-bills, we recommend a slight adjustment to heavier allocation in maturities dated after June, which will be sensitive to any yield movement. Again, however, we do not believe this is necessary, and are not implementing this change with our own investments.

Conclusion

As the recurring political negotiation process around the debt ceiling continues, it will again create some movement in the markets in the very short term. At Treasure, we also think it likely that the negotiations will drag and be resolved at the last minute given the lack of incentive to preemptively resolve the situation. However, the bottom line is that we do not believe a default will occur. Furthermore, we expect that if it were to occur, the impact on Treasury, particularly shorter-dated maturities, will be minimal and resolved within days. As such, we are advising clients to hold on to their existing T-bills (and it’s what our Investment Team is doing with our portfolio!) We will continue to carefully monitor the market and political landscape and adjust our recommendations if needed.

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