To the seasoned finance blogger, US Congressional asshattery lacks the terrifying intrigue it had in 2011.
The world was in worse shape back then. It was pre-LTROs in Europe and high season for Eur-exit speculation, while in the US we were confronting another dispiriting summer slowdown and the legitimate possibility of a double-dip recession. As the possibility that the debt ceiling wouldn’t be lifted in time became frighteningly real, financial markets started flashing signs of acute distress, and consumer confidence cratered.
We got through it. The debt ceiling was raised enough to avoid approaching it again until after the end of the 2012 election. Earlier this year, notwithstanding the Trillion Dollar Coin distraction, the ceiling was raised once more.
And given the many fiscal battles of the past three years, some of which were the result of the 2011 agreement — the fiscal cliff, sequestration cuts, government shutdowns averted by continuing resolutions — it’s all become quite stale. And it’s also been easy to think that once again Congress will come to its senses at the last minute and, at the very least, avoid catastrophe.
But we just came across this piece by Ezra Klein arguing that the dispute between Republicans and Democrats this year is worse than it was in 2011, when they actually agreed on a few things:
In 2013, however, the parties don’t agree on anything:
1) Republicans believe Obamacare’s unpopularity gives them a mandate to defund or delay the law. Democrats believe that their victory in the last election gives them a mandate to implement their agenda.
2) Republicans believe there should be negotiations around raising the debt ceiling. Democrats emphatically don’t. Currently, there are no ongoing negotiations, nor any plan for them.
3) Republicans believe the aim of these negotiations should be defunding or delaying Obamacare. Democrats say they will not, under any circumstances, delay or defund Obamacare.
There is, quite literally, no shared ground for a deal. Democrats and Republicans disagree on everything from the principle of negotiations to the potential objective of those negotiations. …
Most in Washington and on Wall Street hold to a serene faith that the two parties will figure something out. And that’s probably right. But in interviews with both Democratic and Republican staff from the House and Senate leadership, as well as the White House, I have yet to hear a plausible story for how they figure something out.
We don’t have much more to add with respect to the politics, which has never been our specialty. Klein’s points resemble those made in a recent post by Stan Collender, who also worries about the extent to which the Congressional Republican leadership has control over its own members. See also Paul Krugman.
It seems at the moment as if the decision about whether to pass another continuing resolution or shut down the government will come down to the wire next week. A government shutdown wouldn’t be a complete disaster, especially if it’s short-lived, and double-especially if an agreement to get it up and running again helps lead to a deal on the debt ceiling.
Of course, an actual debt ceiling breach is essentially Armageddon. Everyone already knows that. We’ve been scouring our inboxes for helpful research notes on the potential for market disruptions in the period leading up to the deadline, and we finally found one.
Produced by the rates crew at RBC Capital Markets, we post an extended excerpt below and have also chucked the whole thing in the usual place:
The Treasury has said they will run out of borrowing room around Oct 17, at which time they will have roughly $30bn of cash. We think this will allow them to squeak by until Halloween (Oct 31) before they hit the final deadline when they would run out of cash.
But unlike past episodes, it seems that the Treasury is not going to give an exact forecast of when the ceiling will be hit (presumably because they were strongly criticized in 2011 when they had $54bn of cash on the date they said they would be broke). Much like past episodes, namely the summer of 2011, we expect negotiation on this front to come down to the wire.
Let us be perfectly clear: crossing the debt ceiling would be catastrophic.
The Treasury’s systems do not clearly mark what scheduled payments are for what reasons, so it is impractical to try to prioritize payments. And clearing systems like Fedwire do not allow defaulted securities to flow, so the system would seize. In order for the clearing systems to work, the Treasury would need to notify the market of a default almost a day before the default happened (to give everyone time to modify payments), and that is not going to happen because the Treasury will not want to declare default while Congress still has time to pass a bill.
Also the Fed does not take defaulted securities as collateral at the discount window, even if those securities are still trading at par.
No Cross Default on Treasuries
Note that there is no cross default on Treasuries, so in 2011 we saw securities with mid-August coupon payments cheapen to other coupons. This time around, we would expect Treasuries with late October coupons (late Oct or April maturities) cheapen to other issues.
While we think the probability of the debt ceiling causing a technical default in the Treasury market is near zero, nonetheless, there are likely to be market disruptions. The main issue is that the markets are not set up to trade or finance defaulted Treasuries. While many RP documents say that defaulted securities cannot be delivered as collateral, delivery systems are not set up to easily sort out which Treasuries have defaulted and which have not (there are no cross-defaults on Treasuries), so the RP markets can seize up as the debt ceiling drop-dead date approaches. In 2011, the Treasury announced that the debt ceiling drop-dead date was August 3rd. RP rates moved from roughly 2bp to 28bp in the last three days of July and the first two days of August. Once the debt ceiling was raised, rates dropped back to the pre-disruption level.
Bill curve inversion
We expect the Treasury will run out of cash around the Oct 31/Nov 1 date. Much like we saw in the summer of 2011, we expect the Oct 24 and Nov 14 part of the curve will continue to invert as we head through October. Back in 2011 the early Aug to mid Sep bill curve inverted by 18bps. If the debt ceiling debate lingers deep into October we would expect this would play out in similar fashion.