Thoughts on the debt ceiling, x-date, and default risk
We have already reached the debt ceiling and are at the point where the Treasury is exercising extraordinary measures in order to pay the government’s bills. The “X-date” is the point at which the availability of those extraordinary measures will have been exhausted, and without authority to borrow more money, the government will default on many of its financial obligations. As the X-date approaches, the situation will garner more attention from the press and the markets. Treasury Secretary Janet Yellen has estimated the X-date to be June 1st. While that may not be the exact date on which a default would occur, unless Congress passes a bill that the President signs soon, the government will go into default. Just the prospect of a default is harmful, and the consequences of an actual default would be serious and worsen rapidly with every day that passes. Our government’s full faith and credit, which backs its obligations such as Treasury bills, notes, and bonds, is widely viewed as the strongest guarantee in the world. Every time a political stalemate calls the possibility of default into question, confidence in the government’s full faith and credit is weakened.
Possible scenarios from this point in order of severity include: a near-term resolution, a last-minute resolution narrowly avoiding a default, a default lasting a short time, and a default lasting for an extended period. In our opinion, the most likely scenario is a last-minute resolution, though the lack of meaningful progress in reaching a bipartisan agreement for raising the debt ceiling leaves the risk of a short-term default as a foreseeable outcome.
Based on what we consider to be the most likely scenario of a last-minute resolution to avoid a default, we would expect increasing stock market volatility as the X-date nears as a reflection of the uncertainty surrounding the specifics and timing of the resolution. We would expect this volatility to subside rapidly after a resolution is reached, and therefore are not inclined to make major changes to equity allocations for what we expect will be a short-lived phenomenon. Should a default occur, holders of Treasury securities maturing during the default period could see a delay in payment, most likely lasting no longer than a few days. In the event a default occurs, we have the highest conviction all holders of Treasury securities who experience delayed payments will eventually be paid in full. There is no question as to the government’s ability to pay, but rather it’s collective willingness to pay. The question is more about when, not if, the debt ceiling will be raised.
In response to this developing situation, we have decided to suspend purchases of Treasury securities maturing in June through August until a resolution to the debt ceiling issue is reached. This is to avoid potential limits to liquidity resulting from a default while allowing for the possibility of a short-term extension to the debt ceiling to buy more negotiating time to reach a longer-term resolution. Out of an abundance of caution, we may selectively sell existing Treasury securities in cases where those with near-term maturity dates represent a significant portion of a particular account’s anticipated liquidity needs.
We hope this update answers questions you may have as our view of the debt ceiling issue and how best to respond. Our clients’ best interests remain at the top of our minds always.
