US: Debt ceiling posing shutdown risks - Westpac

Washington dysfunction will be on show once again in Sep and Oct when two separate albeit inter-related issues converge – a need to raise the ever contentious US debt ceiling as well as pass a resolution to fund government operations and avert a shutdown from Oct 1, according to Richard Franulovich, Research Analyst at Westpac.

Key Quotes

“A unified government could have been expected to substantially remove risks around a shutdown and the debt ceiling. But, the key players are even more polarised than usual, as the recent legislative failure around healthcare reform shows, and the current Administration has shown a disregard for sticking to established norms. The window is uncomfortably tight too - the House is in its August recess and will sit for just 12 days in September where it must address both issues. All told that guarantees an even more acrimonious debate than usual that will surely go right down the wire. The debt ceiling should eventually be raised, averting a technical default, but our confidence levels are lower than similar episodes in 2011 and 2013.”

“In short, a perfect storm is brewing politically such that keeping the government open and an increase in the debt ceiling is far from guaranteed, even if the White House and Congressional leaders all push for a clean debt increase.”

“Consequences

• Failure to raise the statutory debt limit will leave the US at risk of a technical default via a delayed or missed payment.
• Conservative policymakers believe a breach of the debt ceiling is no big deal – the government can prioritise bills due so that Treasury debt is repaid and "lesser" obligations are paid later, but that may be ill-advised. The US Treasury payments systems are designed to pay all claimants as they fall due and there are no legal or constitutional provisions to address seniority. It is widely feared that clearing and payments systems that rely on Treasury bills as well as markets and activities that rely on them for collateral could freeze up. Money market funds are of course significant holders of Treasury bills and could witness heavy redemption pressures.
• The impact on markets will depend on whether the issue is either a shutdown or a debt ceiling impasse, or both, and the time taken to resolve the issues. The longer it takes for Washington to resolve these issues and the closer the US moves toward technical default the more severe the market reaction. As key deadlines approach without resolution yields on very short term Treasury bills are likely to rise further, risk appetite will take a hit while safe haven flows into longer term bonds should push long term yields lower. With doubts intensifying about the capacity of a Republican-led Congress to push through tax cuts and Fed tightening odds taking a hit the USD should fall, probably sharply, though history is admittedly somewhat inconclusive on this front. Equities will of course take a knock and any real economy hit should at least initially be felt mostly in soft sentiment gauges.
• Markets have tended to treat shutdown and debt ceiling risks as noise too, until the last several weeks, but in this instance the risks are being priced in sooner in the US treasury bill curve, where bills maturing in October have cheapened relative to those around that month.”