Consider this post an appendix to our earlier one on the economic impact of a government shutdown. Here we look at how the approaching debt ceiling limit could disrupt the market for US treasuries. We’ve reported on this before, but here’s a bit more info, courtesy of a Nomura note out on Thursday.
As a reminder, Tim Geithner has said that the limit will be reached by 15 May, though some measures are avaialable to keep the Treasury under the legal limit until about 8 July.
Nomura analysts argue that any impact on rates and spreads will be different to the 1996 “debt ceiling debacle”. Yields on the 10-year USTs rallied during this period, but this was more to do with two 25bps interest rate cuts by the Fed than debt ceiling fears, imply the authors.
US swap spreads were tight through 1995, then rose on the back of a duration sell-off, which was then followed by tightening again later in 1996. However, according to Nomura, this won’t happen again: “uncertainty regarding debt rollover needs should increase Treasury’s borrowing costs and tighten long end swap spreads on the margin.”
So, unsurprisingly given the current state of rich world sovereign debt, this time will be a bit different for the US Treasury as it gets out its bag of tricks to postpone a Debt Issuance Suspension Period. Here’s a handy cut out and keep guide to those:
We reported earlier on how disruptions to the auction and rollover process could reduce prep time for buyers and underwriters. In 2002 a delay to a 2yr note auction caused a weak bid/cover ratio and an additional cost of $19m per year, according to the GAO. Nomura analysts add that a similar case in 2008 led to +50bps of borrowing costs for the US Treasury.
And they add:
We believe that disruptions to the auction cycles will be primarily seen in the front end of the curve, since Treasury would want to limit disturbance to coupon auctions for as long as possible. This is because disruptions to coupon issuance would introduce substantial market uncertainty and potentially result in a higher cost for the Treasury throughout the life of the securities. A less favorable rate on a short-term bill may persist for a short while, but an unfavorable borrowing rate for Treasury on longer-dated securities could elevate costs for years to come.
However, should the situation become more precarious, Treasury may be forced to cut bill supply even further, and potentially delay future bill auctions. In October of 1995, for example, Treasury reduced the supply size of a 13-week bill auction after the initial announcement by $7bn in order to stay within the existing debt limits. In November of 1995, the Treasury also postponed its pre-scheduled 52wk bill auction, again, due to debt ceiling concerns.
A known unknown in any debt ceiling event is what the credit rating agencies may do. In 1996 Moody’s put $387bn of short-term bonds on credit watch for downgrade. Here, again courtesy of Nomura, is the number and face amounts of bonds that could face similar action this time around:
We’d politely point out that the 1995-6 downgrade by Moody’s took place in a different context: the deficit was running at just over 2 per cent of GDP and debt was just shy of 50 per cent of GDP, according to Strategas. The political divide is arguably even wider now than in the Clinton-Gingrich showdown.
Not that any of this seems to be bothering Fitch, which said on Friday:
In Fitch’s opinion, the likelihood of the U.S. government failing to honor its financial obligations and in particular make due and full payments on U.S. Treasury securities is extremely low. Ultimately, the recognition of the dire consequences of failing to raise the debt ceiling in a timely manner will prevail over differences on the more fundamental issue of how best to place U.S. public finances on a sustainable path over the medium- to long-term.
Here’s hoping.
Related links:
Shutdown averted, again, perhaps, or maybe not – FT Alphaville
Chancing on the (debt) ceiling – FT Alphaville
Copyright The Financial Times Limited . All rights reserved. Please don't copy articles from FT.com and redistribute by email or post to the web.