Signed Ceiled and Delivered

how markets will force leaders to expand America's debt load

Only days after a sharp bid in short-term Treasuries had been stirring up fears of a collateral shortage, the next round of financial hysteria has already commenced: 1-month Treasury yields have spiked to near-term highs, performing an abrupt U-turn maneuver. In no time, the narrative has shifted from a safe-asset drought to concerns that global financial players are no longer willing to finance America’s ever-increasing debt burden. All along, however, the culprit in both bouts of Treasury market volatility has been the coming “debt ceiling fiasco”.

Long gone are the worries of a collateral shortage wreaking havoc in America’s sovereign bond market. Despite the largest issuance of U.S. government debt in recent history, the Federal Reserve providing unlimited alternative investments for large entities via its RRP facility, and money market rates remaining above the lower bound of the Fed’s target range, this narrative still received ample approval.

But if a real deficiency had emerged, markets would have let us know quickly, with monetary agencies responding shortly thereafter. Instead, major market players were simply willing to pay a hefty premium for paper maturing before the U.S. government’s “X-date,” the day when the U.S. Treasury exhausts its extraordinary measures and bank account (the TGA at the Fed) and can only fund new obligations by raising the debt limit. Subsequently, rates in the money market complex, from 1-month bills to GCF repo, plummeted.

But that was only until a bigger chokepoint overrode any safe-asset shortage concerns. Fears of a debt ceiling stalemate prompting a U.S. default have now taken center stage, and this time, those fears are authentic. For once, doom-and-gloom is well justified, even if it’s irrational. A delay in raising the debt ceiling not only usually causes turmoil within the political pantomime of U.S. Congress but a stir in the most systemically important market globally: the secondary market for U.S. Treasuries.

While most will point to the negative effects of failing to raise the debt limit on the economy and the political sphere, the short-term impacts on America’s sovereign debt market are much more severe. With politics, a debt ceiling stalemate involves disrupting and revising political goals. But for the Treasury market, the cost of a delay is increased volatility and illiquidity, major threats to monetary leaders’ recent focus on “financial stability”. Each time, those who oppose raising the debt limit deliver their opponents an unintended ultimatum: submit to our demands or face the impacts of a semi-dysfunctional sovereign bond market.

Past scenarios indicate that early symptoms of financial market upheaval force leaders into action. This time is no different. In fact, the stakes are now higher than ever to reach a quick resolution.