Macro + Rates Strategy - US: Facing The Debt Ceiling Again - United Overseas Bank
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Global Economics & Markets Research
Email: GlobalEcoMktResearch@uobgroup.com
URL: www.uob.com.sg/research
Macro + Rates Strategy
US: Facing The Debt Ceiling Again
Monday, 26 July 2021 The US Federal Debt and the Statutory Limit (debt ceiling), which was previously suspended
from Aug 2019 through 31 July 2021 (Sat), is set to expire on 1 Aug 2021 (Sun), if the US
lawmakers do not do anything. US Treasury Secretary Yellen warned that the Treasury will
Suan Teck Kin, CFA
"need to start taking certain additional extraordinary measures" to prevent US default if the
Head of Research
Suan.TeckKin@UOBgroup.com Congress does not act by 2 Aug (Mon), urging Congress to act "as soon as possible" on debt
limit.
Alvin Liew
Senior Economist
Alvin.LiewTS@uobgroup.com There is only a binary outcome to the debt ceiling, either it is raised/suspended, or it is not.
Judging by the US long history of something being consistently done and the expectations of
Victor Yong erring on the side of caution (rather than to experiment with an unprecedented event), our and
Rates Strategist
Victor.YongTC@uobgroup.com om
the markets’ base case is for the debt ceiling to be eventually resolved and raised or
suspended for a period. That said, the polarization of US politics will almost guarantee that
some US lawmakers will once again push the issue to the brink, potentially a repeat of 2011.
The impact from a debt ceiling impasse will be two-fold, the first will pressure short term yields
lower when the US Treasury employs extraordinary measures to conserve cash. This will result
in US T-bills supply reduction and exacerbate the current collateral shortages which will
pressure yields lower. The second impact will occur after the market gets more clarity on the
likely nonpayment window. Securities that mature within the possible nonpayment window will
be sold off causing their yields to spike relative to those elsewhere since investors are likely to
view any nonpayment as a short term problem and still regard US Treasuries as safe haven
assets.
US To Meet Statutory Limit On Its Debt On 1st Aug, Yellen Urges Congress To Act By 2 nd Aug
It is back again. The US Federal Debt and the Statutory Limit (debt ceiling) which was previously
suspended from Aug 2019, through 31 July 2021 (Sat) is set to expire. On 1 Aug 2021 (Sun), if
the US lawmakers do not do anything, the debt limit will be reset from the previous ceiling of
US$22.0 trillion to the current amount of US outstanding debt as the new statutory limited
(estimated at US$28.5 trillion).
In a letter addressed to US Speaker of the House Nancy Pelosi (and copying key Congressional
leaders) on Fri (23 Jul), US Treasury Secretary Yellen told the US lawmakers that the US will
meet its statutory limit on debt on 1 Aug and the Treasury will suspend sale of state and local
government securities (SLGS) at noon on 30 July (Fri). She warned that the Treasury will "need
to start taking certain additional extraordinary measures" to prevent US default if the Congress
does not act by 2 Aug (Mon), urging Congress to act "as soon as possible" on debt limit.
The non-partisan Congressional Budget Office (CBO) in a report (dated 21 Jul) estimated that
if the debt limit is not raised, the US Treasury would probably run out of cash and be unable to
make its usual payments starting sometime in 1Q FY2022, most likely Oct/Nov 2021. That
means, by sometime in the fourth quarter this year, default on federal obligations will ensue if
debt limit is not raised or suspended.
US: Facing The Debt Ceiling Again
Monday, 26 July 2021
1|P a g eWhat is the US debt ceiling?
Like all sovereign countries, the US government must borrow when they spend more money
than they receive. They will do so by issuing bonds and make regular interest payments. The
government debt is the total sum of all this borrowed money. More than one hundred years ago,
the US Congress established the Second Liberty Bond Act of 1917 which included an aggregate
limit on federal debt and also limits on specific debt issues, and in 1939, a general limit was
placed on federal debt, i.e. the debt ceiling.
Since 1960, the debt ceiling has been modified/raised or suspended multiple times (49 times
under Republican presidents and 29 times under Democratic presidents). During the Trump
administration (2016-2020), it was raised/suspended three times (without incident), the last time
being 2019. As noted by Yellen’s letter and various former Treasury secretaries (from both
parties), “increasing or suspending the debt limit does not increase government spending, nor
does it authorize spending for future budget proposals; it simply allows Treasury to pay for
previously enacted expenditures. The current level of debt reflects the cumulative effect of all
prior spending and tax decisions, which have been made by Administrations and Congresses
of both parties over time.”
The important point is that the limits placed on the debt ceiling technically does not have any
influence on government spending or directly limit government deficits, because
expenditures/budgets are authorized by separate legislation.
US Debt Ceiling: What Looms Ahead?
In terms of ownership of US Treasuries, the US Federal Reserve is the single biggest owner, at
around US$5.2 trillion (as of 30 Jun) while more than 75% of the Treasuries are held by the
“public”, including more than US$7 trillion (25%) held by foreign governments.
Holders Of US Treasury Debt
Source: Macrobond, UOB Global Economics & Markets Research
And as inferred by Yellen in the letter, if the US lawmakers do not do anything about the debt
ceiling by 2 Aug, the US does not immediately default. Instead, the Treasury will deploy “certain
additional extraordinary measures" to prevent US default, that is until it runs of cash. The
Treasury cash balance is projected to be at US$450 bn at the time of the debt ceiling
reinstatement and could be exhausted before/by Nov 2021. The assumption is that the cash
balance will be able to tide the Treasury through August, while in September, the US Treasury
will receive tax payments from corporates and individuals. The crunch time will come in October
onwards which will be hard to predict.
US: Facing The Debt Ceiling Again
Monday, 26 July 2021
2|P a g eUS Treasury’s Cash Balance To Meet Its Obligations
Source: Macrobond, UOB Global Economics & Markets Research
A Contentious Debt Ceiling Episode In History – 2011
And in 2011, the US government came to the brink of nearly defaulting on public debt due to
political brinkmanship that delayed raising the debt ceiling under the Obama administration. This
generated real consequences as it resulted in the first downgrade in the US sovereign credit
rating by Standard & Poor (S&P) ratings agency, even though there was no actual default from
the US Treasury. The Dow Jones Industrial Average (DJIA) index tumbled by 12% while the US
Treasury 10-year yields fell by 60bps between 1 and 10 Aug 2011. There were subsequent
episodes of debt ceiling “crisis” in 2013 but it did not result in any further US downgrades.
2011 US Debt Ceiling – Acting Too Close To Deadline, Triggering Credit Downgrade
Source: Macrobond, UOB Global Economics & Markets Research
US: Facing The Debt Ceiling Again
Monday, 26 July 2021
3|P a g e2011 US Debt Ceiling – DJIA Sank 12%, UST 10-year Yields Down 60bps For 1-10 Aug
Source: Macrobond, UOB Global Economics & Markets Research
Outlook – Eventual Resolution But Political Drama Guaranteed?
Given the even more polarized US political environment today (compared to 2011), there are
potential risks of a repeat of the 2011 debt ceiling episode, especially as both Democrats and
Republicans maneuver to position for the upcoming mid-term elections in 2022. US Senate
Minority Leader Republican Mitch McConnell already (21 Jul) signalled his opposition to raising
the debt ceiling in what he calls “this free-for-all for taxes and spending” environment and he
does not expect any of his congressional Republican colleagues to vote alongside Democrats
to renew the federal government's authority to meet its obligations.
Adding to that, the US Fed could also be moving towards announcing “tapering” of QE in August
which may generate “risk off” sentiment and volatility in financial markets until dust is settled.
From the financial markets’ perspective, a US default is “unthinkable” and consequences could
be catastrophic (there has been no precedence of a US default). Also at risk will be the FY2022
Budget plan and US President Biden’s “Build Back Better” program, with both still very much in
discussions.
At the end, this is a binary outcome, either the debt ceiling is raised/suspended, or it is not.
Judging by the US long history of something being consistently done and the expectations of
erring on the side of caution (rather than to experiment with an unprecedented event), our and
the markets’ base case is for the debt ceiling to be eventually resolved and raised or
suspended for a period. That said, the polarization of US politics will almost guarantee that
some US lawmakers will once again push the issue to the brink, potentially a repeat of 2011.
The impact from a debt ceiling impasse will be two-fold, the first will pressure short term yields
lower when the US Treasury employs extraordinary measures to conserve cash. This will result
in T-bills supply reduction, and exacerbate the current collateral shortages which will pressure
yields lower. The second impact will occur after the market gets more clarity on the likely
nonpayment window. Securities that mature within the possible nonpayment window will be sold
off causing their yields to spike relative to those elsewhere since investors are likely to view any
nonpayment as a short term problem and still regard US Treasuries as safe haven assets.
Liquidity conditions remain fairly conducive in the US. After raising the overnight reverse repo
rate to 5bps by the FED, this has served as the new floor for the Secured Overnight Financing
Rate (SOFR). Transaction volumes at the FED’s facility has averaged at US$ 811 bn since
June’s FOMC. Any reduction in collateral from a debt ceiling impasse will only serve to floor
SOFR at 5bps and stimulate demand for the FED’s overnight reverse repos.
US: Facing The Debt Ceiling Again
Monday, 26 July 2021
4|P a g eDisclaimer This publication is strictly for informational purposes only and shall not be transmitted, disclosed, copied or relied upon by any person for whatever purpose, and is also not intended for distribution to, or use by, any person in any country where such distribution or use would be contrary to its laws or regulations. This publication is not an offer, recommendation, solicitation or advice to buy or sell any investment product/securities/instruments. Nothing in this publication constitutes accounting, legal, regulatory, tax, financial or other advice. Please consult your own professional advisors about the suitability of any investment product/securities/ instruments for your investment objectives, financial situation and particular needs. The information contained in this publication is based on certain assumptions and analysis of publicly available information and reflects prevailing conditions as of the date of the publication. Any opinions, projections and other forward-looking statements regarding future events or performance of, including but not limited to, countries, markets or companies are not necessarily indicative of, and may differ from actual events or results. The views expressed within this publication are solely those of the author’s and are independent of the actual trading positions of United Overseas Bank Limited, its subsidiaries, affiliates, directors, officers and employees (“UOB Group”). Views expressed reflect the author’s judgment as at the date of this publication and are subject to change. UOB Group may have positions or other interests in, and may effect transactions in the securities/instruments mentioned in the publication. UOB Group may have also issued other reports, publications or documents expressing views which are different from those stated in this publication. Although every reasonable care has been taken to ensure the accuracy, completeness and objectivity of the information contained in this publication, UOB Group makes no representation or warranty, whether express or implied, as to its accuracy, completeness and objectivity and accept no responsibility or liability relating to any losses or damages howsoever suffered by any person arising from any reliance on the views expressed or information in this publication. US: Facing The Debt Ceiling Again Monday, 26 July 2021 5|P a g e
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