Might the Debt Ceiling Aftermath Push Up Rates?

Might the Debt Ceiling Aftermath Push Up Rates?

June 22, 2023

An investor’s perspective now that the threat of a default has receded

 

The debt ceiling and its implications have long been a topic of discussion amongst market watchers, and new developments have reignited these debates. Recently, we witnessed a critical step forward as an agreement to suspend the debt ceiling until January 2025 was reached.

The positive market response was almost immediate, with the threat of a credit downgrade or default receding. However, as the dust settles, attention is now shifting to how interest rates might react as the Treasury resumes net issuance and replenishes its Treasury General Account (TGA).

Decoding the Debt Ceiling Drama

The debt ceiling crisis began when the U.S. reached its debt ceiling on January 19. Since then, the Treasury has been dependent on the cash reserves in the TGA and the application of "extraordinary measures" to fund its obligations. The lifting of the debt ceiling will see the Treasury replenishing these funds, most notably the government pension funds that were depleted to the tune of around $350 billion.

In addition to restoring these sources, the TGA will also be restocked. Having held a balance of approximately $640 billion over the past five years through 2022, the Treasury will aim to return this account to its typical levels. A Treasury estimate in early May projected that it would maintain a cash balance of $600 billion by the end of September, assuming the debt ceiling issues were resolved. In this scenario, the Treasury would also issue $733 billion in net marketable debt.

 

The Impact on Interest Rates

So, what does all of this mean for interest rates? There's a general expectation that the increased T-bill issuance could exert mild upward pressure on short-term rates for a brief period. However, if we examine past debt ceiling resolutions, it's clear that the Federal Reserve's (Fed) prevailing monetary policy tends to have a more significant impact on yields than increased issuance.

For instance, during periods when the Fed held rates near zero (2011, 2013, 2014), there was little change in yields. In contrast, yields rose during times of rate hikes or in anticipation of a hiking cycle (2015, 2017, 2018, 2021). Similarly, periods of rate cuts saw a decrease in yields (2019).

This suggests that while the resolution of the debt ceiling issue and subsequent actions by the Treasury might influence rates in the short term, it's the broader monetary policy landscape that will have a more profound and lasting impact.

Looking Ahead

As the debt ceiling issue moves toward resolution, investors will need to keep a close eye on the actions of both the Treasury and the Federal Reserve. While the suspension of the debt ceiling and the replenishment of the TGA and other funds might cause a brief spike in rates, it's the longer-term actions of the Fed that will shape the interest rate landscape moving forward.

Investors should stay informed about these ongoing developments and consider reaching out to a financial professional to help them understand the potential impacts on their investment strategy. After all, in an environment as complex as this, informed decision-making is a crucial tool at an investor's disposal.

Important Disclosures

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Past performance is no guarantee of future results.

Treasury bills are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value.

This article was prepared by FMeX.

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