Ratings group Moody’s was pretty sanguine about the US government hitting its $US31.4 billion debt limit last Thursday and the likely lengthy political brawl to follow between the Republican-controlled House of Representatives, the administration of President Joe Biden and the Democrat-controlled Senate.
Moody’s says it expects there will be protracted negotiations that will likely cause volatility in markets, but thinks the US Congress will likely reach an agreement on a new debt limit before the Treasury exhausts extraordinary cash management measures to stave off a debt default before the June deadline.
The story impacted markets Wednesday and Thursday with a lot of talk in commentaries but no real discernible move in prices of bond yields. Falls on both days halved the nascent rebound in the S&P 500 so far this year to just 1.6%.
Markets were actually more rattled by the hardliner attitude of two senior Fed members, both of whom called for higher interest rates – though a third said he would be happy with an increase at the next meeting of 0.25%.
St. Louis Fed President James Bullard and Cleveland Fed President Loretta Mester both supported the Fed raising rates beyond 5%. Fed Governor, Chris Walker made it clear another rate rise is needed in comments on Friday.
The key Federal Funds Fate is presently at 4.25% to 4.50% which would suggest at least three more rate rises of 0.25% each or one of 0.50% and then halving a second.
The Fed meets next week on January 31 and February 1 and markets are now more accepting that rates will rise at that meeting – especially as initial unemployment benefits fell last week under 200,000. That was despite tens of thousands of job losses in tech and finance since early December.
But weak industrial production and retail sales for December (down a sharp 1.1%) have seen some commentators downgrade 4th quarter GDP estimates (the first estimate is out this Thursday) and start changing their rate rise forecasts.
The debt limit brawl will be the litmus test for any market angst about the health of the economy. Some believe the Fed may not lift rates so as to keep the call on government finances as small as possible, others reckon it will be business as usual.
The US government hit its $US31.4 trillion borrowing limit on Thursday as expected. Treasury Secretary Janet Yellen informed congressional leaders including Republican House Speaker Kevin McCarthy that her department had begun using extraordinary cash management measures that could stave off default until June 5.
Moody’s said “the Treasury (had) began targeting intragovernmental debt held by the Civil Service Retirement and Disability Fund and the Postal Service Retiree Health Benefits Fund… the Treasury is also expected to start suspending the daily reinvestment of Treasury securities held by the Thrift Savings Plan’s G Fund, which contains contributions made by federal employees to their retirement.
“By itself, the G Fund will provide the Treasury nearly $US300 billion in headroom under the debt limit.”
“Given an extremely fractious political environment, we anticipate an agreement will likely only be reached very late or in an incremental fashion, potentially contributing to flare-ups in financial market volatility,” Moody’s said in a note on Thursday.
Still, it said it expected the debt limit impasse to be solved before a missed payment occurs.
Moody’s said that should the Congress fail to reach an agreement on the debt limit, the US government would still likely continue to meet its debt service obligations on time and in full, by giving them priority over other payments.
“Our preliminary outlook is that the Treasury could run out of cash and default as early as August. However, if the Treasury makes it to September, a mid-month windfall of corporate tax revenue will likely push back the drop-dead date for lawmakers to avert a default to early October.
But Moody’s warned, “Political brinkmanship over the debt limit is a dangerous game to play. A default would be a body blow to the economy.”
“Financial markets would be roiled, and proposed workarounds to the debt limit such as prioritizing Treasury payments to bond holders, minting a trillion-dollar platinum coin, or invoking the 14th Amendment would do little to subdue the ensuing chaos.”
That would see payments on social security, transfers to the states and other outgoings would be stopped (payments to defence and other essential services will be continued, if past practices are followed).
Recurring legislative standoffs over the debt limits this last decade have largely been resolved before they could ripple out into markets. That has not always been the case, however: a protracted standoff in 2011 prompted Standard & Poor’s to downgrade the US credit rating for the first time, sending financial markets reeling.
S&P still has America’s credit rating at AA plus with a stable outlook. For a while that rating was actually AA plus with a negative outlook. Moody’s and Fitch are AAA stable. (That’s lower than Australia’s AAA rating)
Moody’s said that while a missed interest payment by the US was unlikely, it would consider it an event of default.
“A missed payment would have negative credit implications for the sovereign, but we would expect the default to be short-lived and cured with full recovery,” it said on a note on Thursday night.
A potential rating downgrade would be limited, leaving the government close to its current triple-A status due to its capacity to repay debt, Moody’s said, but it would likely affect the ratings of other borrowers such as companies and financial institutions exposed to the US government.
The US Congress adopted a comprehensive debt ceiling, the statutory maximum of debt the government can issue, in 1939, intending to limit its growth.
But like so many ‘good ideas’ from politicians, the measure has not had that effect, as, in practice, Congress has treated the annual budget process — deciding how much money to spend — separately from the debt ceiling — in essence, agreeing to cover the costs of previously approved spending.
The usual partisanship of the Republicans on this particular debt limit was underlined by the way they backed multiple increases to the debt ceiling when Republican Donald Trump was President.
