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May 2023 Market Brief
Insanity
“Reader supposed you were an idiot. And suppose you were a member of Congress. But I repeat myself.”- Mark Twain
While this is a rapidly developing story (that may even get resolved by the time I release this brief), it’s important to discuss the current debt ceiling debacle. This is, by far, one of the dumbest games of chicken we have played economically and politically in decades. Yes, we did something similar back in 2011 and apparently, we never learned our lesson. Treasury Secretary Janet Yellen has listed June 1, 2023, as the X date that the US Government will no longer be able to pay their bills due to the debt ceiling being reached and the Treasury Department legally unable to issue more debt. The X date has been called into question, as cash balances of the US Government fluctuate daily depending on tax receipts and spending. There is a June 15th tax filing deadline that may bring in more revenues and a reprieve, but Secretary Yellen feels there is a very low probability we will be able to reach June 15th.
So, what happens if we reach the ceiling without an agreement to raise it? Technically, we hit the $31.4 Trillion current limit on January 19th, 2023, but the Treasury department has been using what they call “extraordinary measures” to keep the lights on as they move monies around. Basically, come June 1st the US government believes it would default; just like you or I can default on a home mortgage or a credit card bill by not paying our obligations. Again, a reminder that these monies have already been allocated and spent by Congress. This is not a fight over the budget (though the budget drives deficits), this is us refusing potentially to pay current, agreed upon obligations. Obligations such as social security, US Treasury bills coming due, and even basic bills every business has such as rent, salaries, benefits, contracts, and utilities.
In 2011, the Treasury did generate a contingency plan for a default, and it is likely we would follow those guidelines if we hit the limit. Under this plan, the Treasury would prioritize paying US debt and not defaulting on bonds. They would pay interest on treasury securities, and as securities mature, Treasury would pay those principal balances by auctioning new securities for the same amount. This would hold the total aggregate amount of debt stable. They then prioritize social security and focus on delaying any other obligations. Delays in other federal obligations will likely result in immediate legal challenges. Honestly, any of the options floated as emergency options will face very steep legal challenges. Those include the Trillion Dollar Coin, suspending the debt ceiling (without Congress), use of the 14th amendment, and even prioritizing payments.
The outcome of a default event would likely reverberate for decades. Already the Credit Default Swaps on US 1-year bonds have soared well above 2008 and 2011 levels to over 140bps. Financial people are taking this tail risk event very seriously and taking moves to hedge against a default. With $31T debt outstanding, even a 1 basis point increase in costs to issue would add $3.1 Billion in interest costs annually. A default event would likely further strip the US of its AA+ rating by S&P. AAPL currently has a higher debt rating than the US Government. Moody’s analytics estimated the unemployment rate would rise to 8% with a prolonged breach, as well as fairly dire warnings on how the stock market would plummet.
Raise the ceiling and work on a better budget when the consequence of no agreement doesn’t cost us hundreds of billions annually in higher interest costs for decades to come. It’s not just about June, it’s about our future credit worthiness.