Explanation: What an extension of the US debt ceiling means for the bond markets

NEW YORK, October 12 (Reuters) – The deadlock over the US debt ceiling may have been temporarily resolved, but a longer-term solution has also been postponed. Last week’s truce calmed the bond market a bit, but investors are still considering default risks ahead of another December deadline.

WHAT IS THE DEBT LIMIT NOW?

After weeks of wrangling, the US Senate approved the extension of the debt ceiling, the maximum amount the US government can borrow as directed by Congress to meet its financial obligations, from $ 480 billion to what is now $ 28.9 trillion. It is now going to the United States House of Representatives for a vote on Tuesday before President Joe Biden can sign it. This should cover debt financing needs at least until early December. Read more

This will give Congress more time to pass an extension of the longer-term debt ceiling through reconciliation, analysts said. BofA Securities, in a research note, said it believed funding for the U.S. Treasury could go beyond December and into January or even February.

WHAT SHOULD THE US TREASURY PAY FROM THE INCREASED DEBT LIMIT?

The US Treasury is expected to spend two-thirds of the $ 480 billion in new borrowing authorizations soon enough. Money market research firm Wrightson Capital, in a research note, said the Treasury, by law, must restore balances in trust funds that had been divested during a “debt suspension period.” (DISP). As of Friday, the latest Treasury debt ceiling activity weekly report showed government trust funds owed $ 301 billion in non-marketable securities as of October 6. Wrightson said replacing those trust fund securities would leave the Treasury with less than $ 200 billion in traditional borrowing power when the debt ceiling increase officially takes effect later this week.

COULD THE TREASURY STILL USE EXTRAORDINARY MEASURES IF THE $ 480 BILLION WAS OUT?

Wrightson’s estimates showed the Treasury would likely use up the rest of its regular borrowing by the first week of November. If so, Treasury Secretary Janet Yellen may have to declare a new DISP, which would allow the department to once again tap into its extraordinary measures. This gives the Treasury about $ 300 billion in accounting flexibility, which should be enough to eventually cover all of its borrowing needs, for the remainder of the year, Wrightson said.

WILL THE OFFER OF TREASURY BILLS INCREASE WITH THE INCREASE IN THE DEBT LIMIT?

BofA Securities predicts that there could be a more than $ 300 billion short-term increase in the supply of bills after signing the short-term debt limit. This estimate is based on existing and target treasury cash balances. The invoices will likely take the form of short-term monthly cash management invoices.

WHAT ARE THE SHORT-TERM MARKET IMPLICATIONS OF THE DEBT LIMIT EXTENSION?

As a result of the extension, the risk of a short-term default has eased or even deferred to December. The thinly traded one-year credit default swaps that would pay off in the event of a U.S. government default traded at 14.9 basis points last Friday, after hitting 28 basis points before the increase in the debt limit.

Yields on US bonds, maturing at the end of October, also fell. For example, the yield to maturity on October 26 fell to 4 basis points last Friday, from nearly 20 basis points last week. Pressure shifted to early December maturities, however, where yields doubled. The yield to the December 7 maturity fell to 8 basis points last Friday, down from 4 basis points a week earlier.

Outside of the ticket market, however, there are few signs of stress. In the US repo market, investors are keeping a close eye on the treasury bill guarantees promised to them in overnight and forward transactions. Barclays, in a research note, wrote that although lenders monitor CUSIPs or debt ceiling sensitive ID numbers, they have not excluded them from the eligibility list. This suggests some expectation of a debt ceiling resolution.

Reporting by Gertrude Chavez-Dreyfuss; Editing by Megan Davies and Paul Simao

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