The Treasury bill yield curve says the probability that the U.S. government won’t raise the debt ceiling in time to avert a technical default — a failure to make an interest payment on time — is about 15%.
That’s based on a simple formula that looks at the elevated yields on bills that mature around the time the government is expected to exhaust its borrowing authority in mid-October, compared with the yields on bills due before and after.
Bills due in late September and early November yield about 0.975 percent. Until a couple of months ago, so did bills maturing in mid-October. Since then, mid-October yields have climbed into the 1.10% to 1.15% range, approaching yields on bills due a year from now.
“Assuming there won’t be anything else going on in the economy, in principle those yields should also be 0.975%,” said Niso Abuaf, who heads the financial strategy group at Ramirez & Co. in New York. “From that, you can deduce a default probability.”
The divergence accelerated this week after President Donald Trump threatened a government shutdown if Congress doesn’t fund a border wall. Markets viewed the threat as complicating prospects for a debt-ceiling agreement, even as congressional leaders pledged to avert payment delays.
Here’s how to calculate the probability:
Normal rate = (elevated rate) * (1-default probability)
0.975 = 1.15 (1-default probability)
0.15 = default probability
The debt ceiling stands at $19.8 trillion. The government has been using extraordinary measures to stay under it since March, and is expected to exhaust those sometime between late September and early November. Uncertainty about tax payments and any government shutdown make it impossible to determine exactly when.
S&P Global Ratings downgraded the U.S. rating in August 2011 amid debt-ceiling negotiations that threatened to delay interest payments.
Elevated yields on bills maturing in October show “the market is expecting a lot of activity in that time period,” Abuaf said.
The likelihood of default is subject to debate, however.
“It’s a very simple model,” he said. “I’m sure people can build more complex models as well.”
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