We address the following questions:

  • Where are we with the debt ceiling?
  • What happens if there’s a default?
  • Are money market funds safe?
  • What are the likely options in the next few days?
  • How should I invest while the debt ceiling remains unresolved?

Where are we with the debt ceiling?

The U.S. Treasury is weeks away from running out of money. The U.S. government debt limit is $31.4 trillion and the total amount of debt outstanding is $31.4 trillion. The only reason the U.S. Treasury has not stopped issuing net new debt in the last few months is because Treasury Secretary Janet Yellen says the U.S. has taken “extraordinary measures.”

There are three “extraordinary” measures.

  • One, withholding crediting the $292 billion “G-Fund” in the Thrift Savings Plan (a sort of 401(k) plan for government employees).
  • Two, postponing investments in the $965 billion Civil Service Retirement and Disability Fund, which pays benefits to retired federal employees.
  • And three, reducing cash held at the $17 billion Exchange Stabilization Fund, which is used to remit overseas aid and balance any exposure the U.S. government may have to foreign exchange payments.

In each case, the U.S. Treasury effectively wrote IOUs and will credit each account when its able to borrow more. The sum of all three extraordinary measures is around $230 billion and there’s probably not much left of that for the U.S. Treasury to access.

Once those sources are tapped out, the U.S. Treasury has two remaining sources of cash.

First is the Treasury General Account, which is where one federal agency, say Customs, deposits excise duties, and another, say Defense, makes payments to contractors.

The second is the daily inflows of tax receipts, which vary a lot depending on the time of the year but are about $14 billion per day in May of 2023. The Treasury then makes payments every day which in May they averaged about $25 billion a day. The U.S. thus runs a budget deficit and the shortfall is what the U.S. Treasury needs to borrow from the public.

As of May 23, 2023, the special measures are running out. Tax receipts are coming in, with some big ones coming in early June, and payments are going out. As long as the payments are greater than the receipts, the U.S. Treasury needs to borrow and if it can’t, it either has to stop repaying bonds or cut spending.

What payments does the U.S. Treasury have to make?

We know most of the transactions every day. For example, on June 1, 2023, the U.S. Treasury must make a $47 billion payment to Medicare, a $12 billion payment to retired military personnel and a $12 billion payment to the Veterans Benefits Administration. It also must pay $25 billion every Wednesday to Social Security beneficiaries and $6 billion to Federal Employees.

Some days the U.S. Treasury receives in taxes what it pays in benefits but generally the inflow is less than the outflow. Normally, the U.S. Treasury would then borrow the difference. The payments the U.S. Treasury, whether they are wages, benefits, or interest payments are fixed, legal and binding. The “X-date” is simply the day when those obligations are all due. But… without enough revenue to cover them. For now, let’s stay with Secretary Yellen and assume that day is June 1, 2023.

What happens then?

The U.S. Treasury can do one of four things:

  1. Prioritize payment: This simply means one of two things. One, that the U.S. Treasury pays bond holder ahead of everyone else. Or two, payments are delayed until there’s sufficient money to cover all bills. The U.S. Treasury has stated in very clear terms that it does not want to either.
  2. Issue never-used securities: These include selling a trillion-dollar coin or issuing perpetuals or high coupon notes. We’ve discussed them here and here but they are not relevant today.
  3. It ignores the debt ceiling and carries on like nothing happened. This is the 14th Amendment clause.
  4. It defaults

Let’s go with number four as it’s the only option that doesn’t run into unprecedented legal problems

The U.S. Treasury will not default in the normal sense of the word. The U.S. is capable of and willing to pay all its bills. It does not have a credit problem.

But there is a risk of a “technical” default which is what happens if a principal repayment is not made, usually within three days of the due date. In this case, the U.S. Treasury and holders of Treasury bills (T-Bills) would come to an agreement of when and how to make full repayment.

If that happens, holders of bills maturing in early June will not receive their principal. Holders of the bonds would then wait until the Treasury had enough money to repay the bill. Note, we’re only talking about Treasury bills, which are short-term securities issued below par value and repaid at par. So, if the Treasury issued a bill a year ago at $97 and now repays it at $100, the $3 counts towards the debt ceiling. Coupon bonds, issued from 2 years to 30 years are issued at $100 and repaid at $100. So, a maturing existing coupon bond does not count towards the debt ceiling and is simply rolled or reissued. That’s why we will see plenty of issuance of bonds and bills even if the debt ceiling is not lifted. It’s simply debt being rolled over. For today’s purposes, we’re only talking about the risk to T-Bills.

If you’re now holding a T-Bill that the Treasury won’t repay at par, the options are to sell it or wait. Back in 2011’s debt drama, the Fed said they would buy T-Bills at face value, but have kept quiet this time round.

Again, we would stress that a technical default is not a great look for the U.S., but investors will be repaid in full. They will not lose money.

What happens to bills held by money market funds? Are they safe?

Many money market funds have moved out of bills maturing in June. There are $769 billion of bills maturing in June and money market funds held $103 billion in April. It’s almost certainly lower now as money market funds mostly hold longer maturities than one-month bills. The same money market funds also deposit cash with the Fed overnight in return for holding bills. The bills they hold overnight are retuned to the Fed and are considered very safe and liquid.

Are money market funds safe and not subject to default risk?

Yes. We believe money market funds will remain liquid and priced at a $1 net asset value (NAV). They have a lot of flexibility to hold different maturities and can always borrow from the Fed. This applies to government and Treasury money market funds. Ultra-short bond funds and some prime money market funds may have a floating NAV.

Sum it up, please.

Here are the seven likely scenarios over the next week.

Debt Ceiling 7 Possible Paths

Our base case is that there will not be a default and there will be some bargain that either suspends or increases the debt ceiling. The main unknown is whether it’s a short-term fix, for say, six months or extends to beyond the 2024 election. Or somewhere between those two dates.

What are the investment options now?

  1. Maintain a cash position in the portfolio. Please consult your Cerity Partners advisor but we can offer cash management services and investments into Treasury bills beyond the June period, which we believe carries the higher risk.
  2. Consider money market mutual funds, either government-only, agency or Treasury money market funds. Also consider using municipal money market funds for taxable accounts.
  3. Consider investing in longer term, 5-to-10-year Treasuries. If there is a technical default, longer term bonds will be more attractive, as indeed happened in 2011. Again, please check with your Cerity Partners advisor on the appropriate Treasury and other asset holdings for you.
  4. We would not sell equities. It is highly likely that the Fed would step in and either stop raising rates, lower rates or suspend the selling of Treasuries and mortgages on its balance sheet. It would seek to rebuild confidence with easier monetary policy. That is usually a good time for equities.
  5. Avoid timing markets. When the debt ceiling was resolved in 2011, stocks rose 23% in the next six months. When the 2013 debt ceiling was resolved, the market rose 10% in the following six months.

Here is a summary of the above under different scenarios.

What is debt ceiling is not passed

Markets are nervous and another day without progress adds to the sense of unease. However, we know this:

  1. U.S. companies just reported solid earnings, often surprising analysts with better numbers than expected.
  2. Overseas markets, especially in Japan and Europe have had a good start to the year.
  3. The Fed is nearly finished on further rate hikes.
  4. The long end of the bond market has been strong this year and remains stable.
  5. The main economic indicators, such as employment and services, are weaker but not signaling any sharp recession.
  6. The U.S. Treasury and dollar are highly regarded. A worst-case technical default is highly unlikely to diminish their market strength or standing.
  7. We consider an intentional default highly unlikely but will continue to monitor developments and advise on any changes.

Please contact us with any questions

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