By David Enna, Tipswatch.com
Here’s an update on my last article, “Looming debt crisis is already roiling Treasury bill market,” which discussed the disruptions rippling through the bond market as the U.S. nears a debt-limit crisis.
Moody’s Analytics, a market research firm that is a subsidiary of Moody’s Corp., just issued an April 2023 analysis with new information about the debt crisis and the approaching X-date, when the Treasury will run out of cash needed to pay the government’s bills on time.
A key point in the analysis is that the date appears to be coming earlier than researchers originally thought:
The Treasury debt limit—the maximum amount of debt that the Treasury can issue to the public or to other federal agencies—was hit on January 19, and since then the Treasury has been using “extraordinary measures” to come up with the additional cash needed to pay the government’s bills.
Nailing down precisely when these extraordinary measures will be exhausted … — the so-called X-date — is difficult. It depends on the timing of highly uncertain tax receipts and government expenditures.
Since Moody’s Analytics began estimating the X-date early this year, we have thought it to be in mid-August. But April tax receipts are running 35% below last year’s pace, which is meaningfully weaker than anticipated. And despite weaker tax refunds than anticipated, it appears that the X-date may come as soon as early June. If not, and Treasury is able to squeak by with enough cash, then the X-date looks more likely to be in late July.
The Moody’s report reinforces my argument that the debt crisis is beginning to be seen in clear disruptions in the bond market. It says:
Time is running out for lawmakers to act and increase or suspend the debt limit, and global investors are suddenly focusing on the risks posed if they do not act in time.
The analysis points out that credit default swaps on U.S. Treasurys — the cost of buying insurance in case the Treasury fails to pay its debt on time — have jumped in recent weeks, to levels even higher than past debt-ceiling disruptions.
At close to 100 basis points, CDS spreads on six-month and one-year Treasury securities are already substantially more than in 2011 when that debt limit drama was so unnerving it caused rating agency Standard & Poor’s to strip the U.S. of its AAA rating.
The analysis also notes the recent sharp decline in the yield of the 4-week Treasury bill, which was the major point of my article earlier this week:
As it has become clear in recent days that April tax receipts were coming in weak and the X-date may be just a few weeks away, investors have piled into the safety of one-month Treasury securities. Yields have plummeted, from 4.75% at the start of April to less than 3.4% currently. At the same time, yields on three-month Treasury bills have continued to rise. The difference between one- and three-month Treasury bill yields has never been as wide. Global investors thus appear to be attaching non-zero odds that the debt limit drama will end with a default sometime in June or July.
The GOP spending proposal
The analysis goes on to examine the ramifications of the House Speaker Kevin McCarthy’s proposal to roll back discretionary U.S. spending in 2024 to 2022 levels — in exchange for a one-year increase in the debt limit. It’s an interesting analysis, and I’ll let you read it and reach your own conclusions. It seems highly unlikely that McCarthy’s proposal will end up being the final settlement of this issue.
At any rate, the White House issued a statement Tuesday declaring that if McCarthy’s bill reached President Biden’s desk, “He would veto it.”
Moody’s Analytics notes that the Treasury debt limit drama is heating up and is likely to get much hotter in coming weeks. It notes:
If the X-date is as soon as early June, it seems a stretch for lawmakers to come to terms fast enough, and they instead will likely decide to pass legislation suspending the limit long enough to line the X-date up with the end of fiscal 2023 at the end of September. This will buy some time …
Getting legislation that funds the government in fiscal 2024 and increases the debt limit across the finish line into law will surely be messy and painful to watch, generating significant volatility in financial markets. Indeed, a stock market selloff, much wider credit spreads in the corporate bond market, and a falling value of the U.S. dollar may be what is required to generate the political will necessary for lawmakers to avoid a government shutdown and breach of the debt limit.
My thinking has been that Congress will eventually have to kick the debt-limit issue down the road to avoid severe disruptions to the bond and stock markets. Moody’s suggests the extension could be to September, when we could relive this crisis again.
But the political divide — and the resulting game of chicken — seem a lot more severe this year, with just a few GOP House members potentially able to block any compromise. In a hopeful note, Moody’s concludes:
But when all is said and done, the legislation that lawmakers ultimately pass will likely be anticlimactic, allowing both House republicans and president Biden to declare political victory.
What should we do?
In a worst-case scenario we could see a repeat of August 2011, a very bad month for the stock market, but quite nice for bonds:
But I suspect that history won’t repeat itself in this way. Bonds benefited in 2011 from increased liquidity supplied by the Federal Reserve, but that might be out of the question in 2023 as the Fed battles inflation. The stock market in recent years has been through the wringer, over and over, and bounced back. But this time, it may not have the Fed as its savior.
I am not a financial adviser and I’ll admit that I am not doing much differently in the lead up to this crisis. For example, some possibilities:
Sell all your stocks and move to cash? One of the big differences between 2011 and today is that cash is much more attractive, with yields above 5% for many short-term Treasurys. In August 2011, the 6-month Treasury bill was paying 0.16%. Today, cash is an appealing alternative. The only problem: How safe are Treasurys in a worst-case scenario? (The answer, in my opinion: still very safe.)
No, I personally won’t be selling out of the stock market. But I could see raising some cash because of the chance to …
Snap up attractive yields when you see them. This week I bolstered my bond ladder by buying a two-year, brokered, non-callable Morgan Stanley CD paying 4.7%. The 2-year Treasury note auctioned Tuesday at 3.97%, so the CD is a better deal. (This is in a tax-deferred account, so the state income tax issue doesn’t apply.)
Watch for market chaos. There could be a buying opportunity, and it could be as short as a few hours of a single day. I’d expect yields on some short-term Treasurys to begin rising higher in coming weeks, as the fear factor sets in. Then … a compromise is announced and everything moves back to what we now call “normal.”
Do nothing. Not a bad option. In the long term, the market will adjust. In 2011, after a miserable August, the S&P 500 ended the year with a total return of 2.1%, followed by 16.0% in 2012 and 32.4% in 2014.
What do you think? Tell us your strategy in the comments section below.
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David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. I Bonds and TIPS are not “get rich” investments; they are best used for capital preservation and inflation protection. They can be purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.
I know the redemption would not count against the purchase limit, but if I redeemed to my Treasury Direct account…