Market stress builds as debt ceiling deadline approaches.

Signs of stress are building as the deadline for lawmakers to act on the debt ceiling approaches, and negotiations are strained.

Market indicators this week suggest rising fear about the possibility of the Treasury missing payments after Treasury Secretary Janet Yellen said Monday that the U.S. may be unable to pay its obligations as soon as June 1.

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The date, less than a month away, upped the urgency for a solution.

Lawmakers are firing with real bullets now that we’re potentially within a month of hitting the debt limit. Delays and refusals to negotiate will soon be getting to the point where it creates a legitimate danger of going off a cliff. Bank of the West chief economist Scott Anderson argued that the “true existential threat” to the economic outlook is a congressional failure to act on the debt ceiling.

Market Indicators

• Yields on Treasury securities maturing in June, around the time the government is thought to run out of ability to pay all of its incoming bills on time and in full, are now higher than most of the yields for those maturing before or after that month, according to Tuesday’s readings.
• Treasurys maturing on June 15 have yields of about 5.29%, while those maturing on May 15 have yields at or below 5%. Those maturing in September and October all have yields below 5%.
• Credit default swap spreads for Treasury securities have been widening. The cost of insuring against a Treasury default over the coming year is now the highest on record – far surpassing levels seen in the 2011 debt ceiling crisis or during the 2008 Great Recession.

McCarthy offered up a plan that would raise the debt ceiling over the next year either by $1.5 trillion or until March 31, 2024, whichever comes first. But the plan would cut back on spending and includes machinations that are unpalatable to Democrats in the Democratic-controlled Senate, such as beefed-up work requirements for welfare.

Still, some of the general nervousness and volatility of the markets, such as declines in the stock market, can be at least partially influenced by the saga with the debt ceiling. The U.S. hit its $31.4 trillion debt ceiling in January, and Yellen said that Treasury would begin taking “extraordinary measures” to temporarily stave off default. The measures essentially amount to shifting money around government accounts in order to pay incoming bills without issuing new debt. But this week, she said those measures will soon be exhausted.

The urgency of the situation has seemingly dawned upon President Joe Biden and Republican leadership in Congress. Just days ago, the Biden administration still had its feet dug in on raising the ceiling without spending cuts, and Republicans vowed to reduce spending. Now both sides have agreed to start talking. Biden invited House Speaker Kevin McCarthy (R-CA) to the White House after Yellen’s warning on Monday.

Riedl said that he thinks that this week, negotiations in Washington, D.C., may take on a more serious tone and markets may start to become more nervous as each day ticks closer to the dreaded X-date. And as the X-date gets closer absent a deal, there will be a bigger reaction in the markets. Riedl pointed out that during the debt limit scare in 2011, interest rates rose and ended up costing the federal government about $1.3 billion in higher interest costs.

In 2011 Standard & Poor’s downgraded the country’s credit rating, having it fall below AAA for the first time in history. There is also the possibility that such a downgrade could occur again if the government comes too close to the deadline.

Adding to the mounting pressure is that the House will only be in session for 12 days this month, while the Senate will be in session for just over two weeks.

Some lawmakers have expressed a willingness for a temporary fix, which would essentially just mean kicking the can down the road in order to allow more time for negotiations. For instance, last month, the bipartisan Problem Solvers Caucus floated suspending the debt ceiling through the end of the year.

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