In many ways, the thought that the United States of America would default is utterly preposterous.
The nation has never repudiated its debt. The full faith and credit of the federal government has been a cornerstone of U.S. policy since the days of Alexander Hamilton. And no one really questions America’s ability to pay.
But in the age of Trump, Wall Street isn’t taking anything for granted.
While Republican leaders are confident their party can set aside its differences to resolve the latest debt-limit impasse before the clock runs out sometime between late September and mid-October, investors are shying away from Treasury bills earlier than they have in the past. Last month, they pushed up costs at a sale of three-month bills to the highest since 2008.
Of course, this song and dance over the debt ceiling has become a biennial ritual of sorts on Capitol Hill: A manufactured crisis created by hardline Tea Party Republicans, which causes lots of hand-wringing but always gets worked out before anything really bad happens. Just this month, Mark Meadows, a leading House conservative, appeared to soften his demands and indicated he was optimistic about getting a deal done.
But with a president who’s willing to say the U.S. government “needs a good ‘shutdown, ’” a growing number of investors in the world’s most important market aren’t taking any chances.
“Everybody just gets a little concerned that with the volatility of this administration, some different path could be taken,” said Deborah Cunningham, chief investment officer for money markets at Federated Investors, which oversees $242 billion in money funds.
What’s at stake goes beyond America’s credibility in the global debt markets. Not only does the U.S. government owe $7 billion in interest on Oct. 2, it’s also on the hook for $48 billion for Medicare, pay for active-duty military members and benefit payments for civil service and military retirees.
Federated is one of several firms avoiding T-bills that mature shortly after Sept. 29, when Treasury Secretary Steven Mnuchin estimates the government will no longer have enough cash to pay its obligations. Because the United States is constantly issuing short-term debt, any lingering worries could lead to steeper costs for taxpayers when it sells four-week bills on Sept. 5 and Sept. 12.
In and of itself, passing a “clean” bill to raise the debt limit shouldn’t be hard. But Congress, which returns from its summer recess on Sept. 5, won’t have a lot of time. The House will have 12 working days, and the Senate 17, to raise the debt ceiling, based on a letter Mnuchin sent to Speaker Paul Ryan.
The political dysfunction within the Republican Party, which controls both chambers, doesn’t help. Differences between moderates and conservatives torpedoed the GOP’s attempts to change the Affordable Care Act, something Republicans have vowed to do for years. And they still haven’t tackled many of President Donald Trump’s campaign promises like tax cuts or infrastructure spending.
OMB Director Mick Mulvaney (Photo: Congress.gov)
It’s not like this issue came out of nowhere: After the Treasury reinstated the debt ceiling in March, it has had to use “extraordinary measures” to help it keep paying its bills.
Costs of Brinkmanship
The costs of brinkmanship are real. The Government Accountability Office said that U.S. borrowing costs increased by $1.3 billion in 2011 because of the debt limit impasse that year, which also led to an unprecedented downgrade from S&P Global Ratings. A separate report concluded that in 2013, investors avoided Treasury bills coming due during debt crisis that year.
Then there’s the added wild card of Trump, whose unpredictable and, at times, volatile persona has fueled investors’ jitters.
Back in 2013, when wrangling over the debt limit coincided with a potential government shutdown, three-month bill rates held steady in July and August and didn’t start to spike until about two weeks before the Oct. 17 drop-dead date. This time, investors didn’t wait. At the July auction of three-month bills (which come due right around the current October deadline), buyers drove up rates to 1.18%, the highest since the credit crisis.
While Office of Management and Budget Director Mick Mulvaney said last week the administration is unified in asking lawmakers to raise the debt limit without any conditions that might provoke a drawn-out fight in Congress, he and Mnuchin also have at various times this year given conflicting signals.
Mulvaney, a founding member of the Tea Party movement’s hard-right House Freedom Caucus, has in the past suggested using the debt ceiling bill to try and force changes in the budgeting process.
Investors are nervous since they’re “uncertain when Treasury runs out of cash,” said Justin Mandeville, a fund manager at Invesco, which oversees $812 billion. “This is a new administration and we’re still trying to get our bearings in terms of Congress being able to come together and pass legislation.”
In spite of it all, many inside the Beltway are taking things in stride. Lawmakers suggest that somehow, everything will work out in the end, as it always does. There’s plenty of support in the Republican establishment to work out a deal and avoid a debt crisis.
“This is a little bit like ‘The Perils of Pauline,’” Tom Cole, a Republican representative from Oklahoma, said on Bloomberg Radio, referring to the century-old silent movie melodrama. “It always looks like the train is going to run over Pauline, but sooner or later, Pauline magically slips out of it. And I think that’s what will happen again in September.”
Nevertheless, getting all the GOP’s rank-and-file members on board is hardly a sure thing. And then there are the Democrats, whose votes will be crucial in the Senate.
“I’m not sure where their heads are,” said Thomas Graff, head of fixed-income at Brown Advisory. “It’s unclear how informed they are, outside of the Treasury, of what this really means.”
“It definitely makes me nervous.”
—-Read Treasury Bill Curve Shows `Red-Letter’ Date Causing Anxiety on ThinkAdvisor.