Navigating the Current Debt Limit Episode
Debates over federal fiscal policy and rising debt levels, along with continued differences in views of government spending priorities, have led to a series of contentious debt limit episodes in recent years.
While the details for each debt limit episode are unique, we are once again facing the prospect of a debt limit stalemate later in the year.
We provide herein some context, our perspective on the current situation and insights into how our portfolios are positioned in light of the latest data.
Key considerations
A potential debt limit episode has presented itself once again, thrusting a possible funding crisis on Congress as early as June.
Although the debt limit has been reached, the so-called “X-Date” (when the use of expected extraordinary measures and borrowing authority are tapped out) is not expected to occur before June 2023 per guidance from Treasury Secretary Janet Yellen.
While uncertainty around the debt limit can be unnerving for investors, we take comfort in the fact that the full faith and credit of the U.S. Treasury has always been honored, and BlackRock remains confident that a default on Treasury debt obligations is a very low probability outcome.
We take the view that legislative and execution risks around debt limit episodes should be respected and factored into portfolio strategies. We continue to closely monitor the situation, seek to manage our exposures in a conservative manner.
What is the debt limit?
The debt limit is the total amount of money that the United States government is authorized to borrow to meet its existing legal obligation.
Treasury Secretary Janet Yellen recently confirmed that the United States reached the statutory debt limit on January 19. She also noted the Treasury began using so-called “extraordinary measures”, which give the Treasury room to operate without hitting the statutory borrowing authority limit.
Secretary Yellen noted that such measures could provide relief until early June, also known as the “X-date”, but the timeframe is “subject to considerable uncertainty.” In the event the debt limit is not eventually raised or suspended, the U.S. Treasury would likely face a funding crisis that could impact a range of federal commitments and strain financial markets.
What are markets telling us?
Prior debt limit episodes have historically had the largest impact on the U.S. Treasury Bill (T-bill) market, typically exhibited as an aversion to maturities deemed by the markets as most vulnerable to potential delayed payment risks from a “technical default.”
In our opinion, conditions are still developing and further risk aversion on the part of market participants is possible in the event given a resolution remains subject to heightened political risks.
What’s the impact on U.S. Treasury issuance?
In previous cycles, T-bill outstandings declined in the run-up to debt limit dates in order for the U.S. Treasury to both comply with statutory borrowing limits and also provide headroom for Treasury coupon settlements. Amid the extraordinary measures, net T-bill issuance has risen over $185 billion this year through the first few weeks of January and is anticipated to continue to move higher over the balance of the first quarter (1) before declining in the lead up to a resolution of the debt limit. We would anticipate a subsequent increase in T-bill supply later in the year upon such a resolution. This additional T-bill supply should continue to provide some relief to current front-end Treasury and repurchase agreement rates.
Are there additional risks associated with ratings downgrades?
Major ratings agencies have published reports on the potential for delayed payment on U.S. debt as a result of the debt limit. According to Moody’s, any missed debt payment would be considered a default, triggering a downgrade of the U.S. sovereign and all Treasury security ratings (2). Fitch Ratings has stated that reaching an X-date without having raised the debt limit could likely have negative implications for the U.S. sovereign rating (3).
Source: TreasuryDirect as of January 24, 2023.
Source: Government of United States: FAQ on the Sovereign Credit Implications of U.S. Government Debt Limit Brinkmanship, Moody's, October 5, 2021.
Source: US Governance, Policy Risks in Focus as Divided Government Looms, Fitch Ratings, November 8, 2022.