Debt Ceiling D-Day

On Saturday, about an hour before he decided to mock the Trail of the Tears while lambasting Elizabeth Warren’s official 2020 announcement, Donald Trump delivered a short “update” on the border wall fight.

“If you believe news reports, [Democrats] are not offering much for the Wall. They look to be making this a campaign issue”, the President tweeted, adding that “the Wall will get built one way or the other!”

Imagine that. Democrats might be looking to make the border wall “a campaign issue”. It’s almost as if there’s some recent precedent for presidential candidates running on a platform centered around border walls.

Trump is of course referring to ongoing bipartisan efforts to craft some kind of border security compromise that the White House would support ahead of the February 15 deadline beyond which Trump has pledged to either shut down the government again or declare a national emergency, with the latter option likely entailing an effort to divert funds earmarked for disaster relief.

As documented here on any number of occasions, going the national emergency route is an absolutely terrible idea, fraught with legal peril for Trump. The optics would be horrendous and the media would pounce on the opportunity to highlight where the money is coming from, raising awareness of the myriad public safety issues arising from the diversion of funds from critical projects. Additionally, the legal hurdles would almost surely put the construction effort in indefinite limbo.

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It looks like negotiators will try and float a deal that includes somewhere between $1.3 billion and $2 billion for a border barrier. Clearly, that’s not going to placate Trump. In fact, it’s likely to irritate him if he considers it a bipartisan insult.

To be clear, nobody wants another shutdown and you can be absolutely sure that no matter what they say publicly, Republicans would rather Trump didn’t declare a national emergency.

But Trump is dug in. His humiliating Rose Garden “fold” to Nancy Pelosi drew the (feigned) ire of immigration hardliners and because he doesn’t understand that most of the media personalities pushing for a literal interpretation of his wall promise are nothing more than shameless profiteers who only care about this issue when the cameras are rolling, Trump is inclined to believe influential right-wingers actually think this is a good idea.

At the risk of downplaying the plight of federal workers (who may end up furloughed again) and subjugating the country’s values to market concerns, we’d be remiss not to note that the “real” problem here is that all of this is now almost certain to get inextricably bound up with the debt ceiling discussion.

Late last month, former semi-credible Beltway mainstay and current raving sycophant, Lindsey Graham, suggested Trump tie the debt ceiling issue to the wall fight, a lunatic idea that would effectively put Democrats in a position of having to choose between building a $5.7 billion tribute to Game of Thrones on the southern border or risk a technical US default. Here’s what Graham told CNN:

The president understands we need to raise the debt ceiling. It comes due in March, so why not just expedite things? I don’t speak for him. I’m just saying, we talked about a package and I think the president basically believes that his priority of barrier funding can be achieved solving other problems also.

In that interview, Graham cited Steve Mnuchin who, as late as January 29, reportedly “liked” the idea of attaching the debt limit to a spending bill.

While Mnuchin may well be in favor of pairing the debt ceiling with the spending bill that needs to be passed in the next five days, you should be absolutely clear about one thing: there is no way that Mnuchin, if you could somehow speak to him privately and he were telling the truth, thinks pairing the wall itself with the debt ceiling is advisable.

If the US were to default as a result of Donald Trump holding out for wall funds, it would validate markets’ worst fears. That is, we would have stone, cold proof that Trump is willing to blow up the financial universe in the service of repairing his bruised ego vis-à-vis one of the most far-fetched campaign promises in the history of US politics.

Two weeks ago, House Ways and Means Committee Chairman Richard Neal sent a letter to Mnuchin demanding that Treasury give him an update on the debt limit ahead of the March 1 deadline, after which Mnuchin will resort to the customary “extraordinary measures” to keep borrowing, likely through August before D-day arrives and the Titanic hits an iceberg. Here’s a table on that from Barclays for those who need a handy pocket guide.

(Barclays)

If you ask Barclays, this is likely to be a nail-biter. “In the highly charged atmosphere of Washington politics, we doubt there will be any agreement to re-suspend the debt ceiling before March 1”, the bank writes, in a note dated February 7, adding that “instead, we expect politicized debates to linger all summer – and the debt ceiling will likely only be re-suspended in the 11th hour.”

To be sure, this isn’t “new” and markets have become somewhat desensitized to it. But as ever, Trump is a wildcard. Time and time again, markets have been blindsided by his willingness to push the proverbial envelope on a number of issues, not the least of which is the trade war, which, contrary to what you might believe if you read the latest analyst commentary, virtually nobody initially expected to escalate to the point things are at now. Similarly, Trump held on longer than many commentators expected during the shutdown, even as the bad press piled up. As such, you can probably expect markets to betray palpable signs of consternation if the debt ceiling issue does “linger all summer”, as Barclays expects.

So, what comes next? Well, by most estimates, Mnuchin can hold out through August. We’ve been over this before, but here’s a bit of new color from the same Barclays note:

Our sense is that its extraordinary measures and expected tax inflows will allow the Treasury to operate at the debt limit through the end of August. In the past the Treasury Secretary has provided an explicit x-date for when it expects to have exhausted these measures. Although Treasury Secretary Mnuchin is likely to remind Congress again about the need to re-suspend the debt ceiling again before March 1, we expect the Department will not be able to pin down the x-date until May. The Treasury’s April tax collections are abnormally uncertain – although the December 2017 tax cut lowered personal tax rates it also reduced the scope of some popular deductions.

BofAML generally agrees that this will come down to the wire.

“We estimate that Treasury has nearly $300 billion of extraordinary measures that can be utilized once the debt limit suspension period ends [and] we tentatively project this should allow Treasury to fund itself until August”, the bank writes, before cautioning (as Barclays does) that “a more accurate estimate cannot be made until after the April tax season and until there is clarity over how the new tax code will impact tax refunds and receipts.”

(BofAML)

Generally speaking, BofAML is also in the camp that believes a quick (read: amicable) solution to this is unlikely in the current environment. To wit, from the same cited note:

Recent debt limits have typically not been resolved until relatively close to the ‘X date’ when forced by threat of market volatility or other political priorities. We think the debt limit may be used as a bargaining chip to find compromise on other policy issues. We think this is the most likely outcome that will probably not see resolution until the summer.

Beyond the obvious read-through for at-risk bills, the broader market implications will depend largely on perception. Obviously, the US cannot truly “default” – you can’t “default” if you print the world’s reserve currency. That doesn’t make any sense. There’s a logical fallacy in there somewhere. But that doesn’t mean Trump couldn’t set off a calamitous bout of volatility if he decides to test the market’s patience. Here’s one more brief passage from the Barclays note that touches on the implications for yields:

Most investors expect any payment delay would be accidental and thus, very temporary. The ratings agencies have adopted a similar approach as a payment delay would not reflect on the US government’s ability to pay its obligations. Instead, it reflects “uncertainty in policy formulation and timely decision making”. A recent study, however, finds that the rate pressure is not confined solely to those issues with payment dates in the red zone. It examined the 2011 and 2013 episodes and found evidence of a “contagion” effect – that is, yields on Treasuries not vulnerable to a payment delay on the x-date also cheapen. Indeed all Treasury yields rose between 4 and 8bp during the 2011 and 2013 events. A separate study found evidence of contagion in the CP market during the 2013 debt ceiling episode. Finally, an examination of the 1979 episode found that the bill payment delay resulted in 60bp “permanent increase” in bill rates – that is, at least through 1989.

As usual, the paradox is that if things get really bad, it could trigger demand for the very securities which are the proximate cause of market angst. That is, if Trump miscalculates, overestimating the market’s willingness to let him slide on this, a risk asset crash could well spark demand for the US long end.

Anyway, the point in all of the above is simply to underscore the fact that the debt ceiling issue is about to take center stage and Trump’s penchant for brinksmanship combined with his increasingly unhinged demeanor and insistence on securing border wall money seems highly likely to make this even more contentious than it usually is.

Fair warning.

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