Morning Brief – Clockwork 

Clockwork 

In the weeks ahead expect to see continued focus upon the impending US debt ceiling. The phenomenon is something that rears its head periodically as the US government kicks the can down the narrow road of an increasingly unsustainable fiscal policy constraint. The provision of a legislative limit on the amount of debt that may be outstanding has been around in the US for more than a century, supposedly in order to maintain fiscal credibility and oversight of the Treasury. In recent years, debt levels have pushed the ceiling and each time that constraint has been raised to allow the accumulation of further debt. 

The debt ceiling is concerning in principle because a breach would on paper constitutionally prevent the Treasury from raising further debt. Particularly in a high interest rate environment, that new debt is required to service interest payments on existing debt. It is easy to identify the spiral that would rapidly lead the US to debt default and further fiscal challenges. Due to the risk that a potential default would create to the global financial system, markets pay considerable attention to any potential breach of the debt ceiling. An approach to the debt ceiling in the past has always been resolved, with Congress often resolving their conflict with the White House during last minute negotiations. However, the perceived stalemate whilst the President’s office pushes for necessary funding and Congress seeks economic compromises elongates market anxiety. 

At present we find ourselves at the beginning of this stalemate, with potential government shutdown as a result of failing to raise the debt limit less than one month away. At present both sides of the debate suggest that there is no room for manoeuvre and that the US is on a fiscal knife edge. The premium on short dated (1, 2 or even 3 month) Treasury bills has grown, with some contracts implying the highest yield on any government paper since 2001. There is clear demand within the market to call the bluff of Congress with buyers of this premium emerging. Whilst the game of chicken always seems to end like clockwork in a last-minute resolution, there is no doubting the potential impact to financial markets should the limit be breached.

Discussion and Analysis by Charles Porter

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