Bond traders are starting to see potential risks beyond the debt cap

(Bloomberg) – Bond investors are starting to look beyond the debt ceiling quagmire even as Treasury Secretary Janet Yellen’s warnings about when the United States will run out of borrowing capacity become more sharp. What lies behind is a little unsettling.

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As the Treasury Department’s cash position has fallen to levels not seen in 2017 and the number of special measures it has to prevent it from violating the legal borrowing limit dwindles, negotiators in Washington are closing in on a agreement to increase the country’s borrowing. ability. As a result, market concerns about the prospect of a jump in Treasury payments have eased somewhat. Yields on short-term bills have retreated from their extremes, as have credit default swap prices. But new worries loom on the horizon, some stemming from the very resolution of the debt crisis that is looking like an increasingly likely possibility.

In the Treasury market, the easing of recessionary risks from the debt ceiling means that attention can once again shift to economic fundamentals and the outlook for Federal Reserve policy, as well as the effect of any potential Congressional agreement on markets and economic activity.

The central bank’s favorite inflation gauge is still hotter than many expected and traders have raised their bets on at least one more tightening from Chairman Jerome Powell in the coming months. Traders have now returned to pricing in a higher interest rate scenario that has been largely absent since concerns over regional banks rocked markets earlier this year and Treasury yields have seemingly risen unabated , with the two-year rate exceeding 4.6%.

Against this backdrop, investors will focus on key macro indicators, such as next week’s monthly jobs report, and analyze public comments from Fed officials.

Any agreement on the debt ceiling itself will likely cast a shadow. If, as seems likely, it includes spending caps, there could be an additional drag on budget growth which, in turn, will impact monetary policy choices. The fallout from the measures taken by the Treasury to rebuild its emaciated cash balance is also worrying. That dwindling pile – combined with the gradual depletion of accounting gimmicks aimed at preventing the US from breaching its cap – saw Yellen once again warn that things are getting tighter, telling lawmakers on Friday that the government expects to be able to make payments only until June 5th.

It also means there will be a lot more issuance to bring liquidity back to more normal levels if and when a deal is struck. The resulting deluge of ticket sales is likely to suck a significant amount of liquidity from the markets, tightening financial conditions and adding pressure at a time when the central bank’s interest rate hikes and balance sheet shrinking of the Federal Reserve are already creating tensions.

“The bond market is looking past the leverage limit now” and refocusing on some of the issues that were prevalent before the March banking upheaval, said Tom Essaye, a former Merrill Lynch trader who founded The Sevens Report. “Next week’s jobs report will be even bigger than some people think because if it’s hot, the Fed will hike again in June,” he said in a phone interview. .

That said, a debt ceiling is not yet in place and observers will remain alert to signs of stress. From Washington to Wall Street, here’s what to watch on the debt ceiling, economy and politics in the week ahead:

Washington’s Quarrels

While White House negotiators and congressional leaders appear to be closing in on a deal, risks remain. The talks could of course stall, but even if there is a deal, it still has to clear various legislative hurdles. Until it becomes law, the government will likely continue to bleed money and eat into the accounting gimmicks it uses to avoid breaching the ceiling. So every day late counts.

“Based on the most recent data available, we now estimate that the Treasury will not have sufficient resources to meet the government’s obligations if Congress does not raise or suspend the debt ceiling by June 5. “Yellen said Friday in his latest letter to lawmakers on the potential timing of a government default.

Cash balance and exceptional measures

The amount in the US government’s current account fluctuates daily based on spending, tax revenue, debt repayments, and proceeds from new borrowing. If it gets too close to zero for Treasury comfort, that could be a problem. As of Thursday, less than $39 billion remained, and investors will be watching closely for each new day’s release of that figure. Emphasis is also placed on the so-called extraordinary measures that the Treasury uses to increase its borrowing capacity. On Tuesday, it was down to $67 billion.

Rating agencies

Meanwhile, hovering above the entire debt ceiling fight is the risk that one of the world’s leading credit assessors may choose to change its mind on the sovereign rating of the United States. Fitch Ratings issued a warning this week that it could choose to cut the country’s top credit rating, a market-shattering step that Standard & Poor’s picked up when battling the debt limit in 2011. This time around, S&P and Moody’s Investors Service have refrained from changing their outlook, although this is potentially a risk and investors are aware of anything the major ratings agencies might say about the situation, even if a deal is reached. concluded.

Economic data releases

  • May 30: house prices; consumer confidence; Dallas Fed Manufacturing Gauge

  • May 31: Mortgage applications; the MNI Chicago Purchasing Managers Index; Jerking Jobs; Dallas Fed Services Gauge; Beige Fed Book

  • June 1: job cuts at Challenger; ADP employment report; non-farm productivity; weekly jobless claims; US S&P Global Manufacturing PMI; construction expenses; ISM manufacturing report; vehicle sales

  • June 2: Monthly Jobs Report

Federal Speakers

  • May 30: Tom Barkin of the Richmond Fed

  • May 31: Susan Collins of the Boston Fed; Governor Michelle Bowman; Philadelphia Fed’s Patrick Harker; Governor Phillip Jefferson

  • June 1: Harker


(Updates with the latest information on Yellen’s cash balance and extraordinary measures.)

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