Debt Ceiling Debacle Could Rattle Markets

Hey There Income Hunters,

Forty-six Republicans have a letter saying they will not vote for an increase in the debt ceiling.

This is a complete game of political chicken.

Failure to pass the debt ceiling would restrict the Treasury from writing any more checks, ultimately forcing the Treasury to default on its debt payments as soon as next month,

The Treasury has already started using extraordinary measures this month by cancelling issuance of six-week cash management T-Bills, which will give Congress more time to maneuver.

While there have been some close calls in the past, the debt ceiling has always been raised before its deadline.

Why Does the US Even Have a Debt Ceiling?

Prior to World War I Congress was required to approve each spending bill … The last segregated spending program was the 2nd Liberty Loan of 1917

 Here’s a promotional flyer for the sale …

That’s pretty good copywriting!

As spending increased, Congress needed more capacity to borrow, so they agreed on an established aggregate limit and the debt ceiling was born …

As political warfare grew over time, the debt ceiling became a critical negotiating tool …

But negotiations were taken to a new low under President Obama … 

Debt Ceiling Crisis of 2011 and 2013

The debt ceiling has always been a political pawn. Under Obama, the gamesmanship really heated up as the Republican party tried to force the president to negotiate over deficit reduction in exchange for raising the debt ceiling.

Just two days prior to expiration of the Treasury’s borrowing authority, Congress agreed on future spending cuts and the debt ceiling was raised …. 

But not without serious market turmoil:

      • Stocks dropped about 10% leading into the final agreement …
      • Bonds, using the iShares 20+ Maturity Treasury Bond ETF (Ticker: TLT), were already in a bear market and prices were down 8%.
      • The US Dollar Currency ETF (Ticker: DXY) was down 5%

So, you can see the lack of coordination across parties is negative for all US financial assets …

In 2011 the US S&P credit rating was lowered from AAA to AA+ … This rating downgrade occurred right after the 2011 debt crisis due to deteriorating fundamentals …

What We Can Expect in 2021

Could we see another ratings cut in the future?

Well with 130% debt-to-GDP and many more trillions coming, it wouldn’t be much of a surprise.

I see the greatest impact to the Fed’s reverse repo facility, which just set a new all-time high on Thursday Aug. 12. The balance currently stands at nearly $1.1 trillion …

The Fed reverse repo facility is a Fed borrowing program, which pays lenders of cash .05% plus the loans are collateralized by the Fed with US Treasuries.

So, if the Treasury is pushed to the debt ceiling cap, they will cancel borrowing plans. Maturing Treasuries would then be paid out and all that excess cash would be parked at the Fed.

In the short term we could see a small correction in stocks and the dollar, however, there has been strong support for Treasury bonds by foreigners, so they may hold in the best …

This is more embarrassing than anything and there is no chance Congress. would let the Treasury default. Still, it is good to add the impact as a variable in your trading strategy.

Bring It Home

A busy week of Treasury issuance and inflation numbers has not been met with volatility as stock and bond vol has collapsed.

The technicals are a reliable indicator for larger moves during an illiquid time of year. Keep an eye on a close below the TLT 50-day moving at 145.76 for a further drop in TLT.

Also the S&P 500 Index ETF (Ticker: SPY) is pretty overbought on the weekly chart, which could present some opportunities to play for a bounce in VIX from the low end of the range …

Live and Trade With Passion My Friends,

Griff

 

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