The Market Is Starting To Sweat Over The Debt Ceiling

The Market Is Starting To Sweat Over The Debt Ceiling
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The debt ceiling has reared its ugly head yet again this year, with U.S. lawmakers running up against a tight deadline to pass the federal budget for fiscal 2018 and raise the ceiling. The Congressional Budget Office estimates that the Treasury cash balance will run out sometime in early to mid-October. If that happens before lawmakers raise the debt ceiling, the United States will default on some of its loan payments.

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Bracing for impact... with the ceiling

The Treasury markets are starting to demonstrate concern about whether lawmakers will be able to raise the debt ceiling in time, as seen by the steep jump in yields for the Treasury bills that mature in October. As Business Insider explains, the sudden jump indicates that investors are currently demanding a greater premium to keep holding the bills that mature during the month with the greatest risk of default.

So even though economists generally believe that Congress will get the debt ceiling raised in time, the fact that lawmakers convened for their August recess without doing so has put the fear of failure in the U.S. debt markets. The original plan was to get the debt ceiling raised before leaving for the August recess, but the failed attempts to replace Obamacare took up all the time.

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At the end of the second quarter, the Treasury cash balance stood at $181 billion after borrowing $35 billion during the quarter, officials said. In their update this week, Treasury officials also said they expect to issue another $96 billion in credit during the third quarter, which they estimate will result in a $60 billion Treasury cash balance at the end of September.

Rescuing the Treasury cash balance just in the nick of time

Nomura economists believe lawmakers will pass the new budget, but not until the eleventh hour. In a report earlier this week, Nomura economist Lewis Alexander and team also noted that the Treasury markets were starting to take evasive maneuvers just in case lawmakers don't raise the debt ceiling in time to avoid a default.

They see the current risk of breaching the nation's debt limit in late September or early October as "lower than in 2011 or 2013 but slightly higher than in 2015, when the debt limit was passed with little fanfare." They explained that Congressional leaders have earned how to get around their party's most conservative members. Further, since Republicans control both houses of Congress and also the White House, they're even more motivated than usual to get the debt ceiling raised in time.

Risks remain

However, the Nomura team adds that there are still risks despite Republicans' party-centric incentives to get things done in time. For one thing, they're cutting things close by delaying the debate over the nation's debt until after the August recess. The deadline for passing the fiscal 2018 budget is approaching fast after the debt ceiling.

Further, the Republican Party is still highly fractured, and they note that some support from Democrats has been needed to pass the debt ceiling each year since 2011. However, this year is a bit different because Democrats don't control either of the legislative houses or the White House. Additionally, they believe the House may fear negative consequences of default because payments could be prioritized and the Fed would probably take some actions to calm the markets in such a scenario.

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