What Janet Yellen Sees As Debt Limit X-Date Looms

Let’s be clear: Most of us are working on the assumption the US won’t default, or at least not on principal and interest payments.

Sure, JPMorgan and the other SIFIs have their “war rooms,” places like the CME have given a lot of thought to various adverse scenarios and, annoyingly, that sort of contingency planning can be expensive. But, generally speaking, everyone wants to believe that even in a nightmare scenario, debt service payments will be made.

Much of the analysis you’ll read is thus best viewed from a kind of “This is how close it was” perspective. The debt ceiling discussions are fluid and prone to abrupt turns. For example, after three straight days of upbeat rhetoric, talks were derailed just before the weekend when GOP negotiators, possibly responding to protestations from Kevin McCarthy’s far-right flank, walked out on Biden’s team.

It’s not feasible to document each and every soundbite that may or may not signal something about the state of play, and even if it were, that kind of ambulance chasing doesn’t have any shelf life when it comes to these sorts of issues. It’s stale as soon as it’s written.

That said, I do think it’s worth remembering how close a call this really was for posterity. Although it’s not “eleventh hour” just yet, there’s a very real sense in which this time is different — not everyone involved is entirely rational and the nation is in a much more contentious place politically than it was during previous close calls.

On Friday evening, Goldman gave market participants a glimpse of what Janet Yellen is facing in June. Hopefully, this will all be an afterthought soon enough, but just in case, the bank’s Alec Phillips and Tim Krupa noted that “the June deadline is unusual in that the budget is in deficit for the first half of the month but will run a surplus in the second half [which] means there could be as little as a few days in June when the Treasury cannot make payments.”

The figures above show Goldman’s central, upside and downside scenarios. As you can see, there’s a lot of uncertainty.

Phillips and Krupa cautioned on the risk that “receipts could slow more than expected and leave the Treasury short of cash by June 1 or 2.”

If that were to happen, it could affect Social Security, Medicare and other benefit programs, but Goldman doesn’t anticipate any impact on debt servicing. There’s a coupon payment on June 1.

The next Social Security payment after June 2 isn’t until mid-month, and the same goes for coupon payments. At that point, Goldman noted, Treasury “is likely to be taking in a large amount of tax revenue due to the quarterly tax deadline.”

Phillips and Krupa made a decision tree comprised of “three general scenarios, with several permutations among them.” The three main branches were “Deal before deadline,” “no deal” and “deadline changes.” Goldman assigned 70% subjective odds to a deal, with very low chances of a weekend agreement (10%) and 30% odds each to a breakthrough next week or at the “last minute.”

Under the “no deal” scenario (25%), there were a trio of possible outcomes, including “Treasury ignores debt limit.” Goldman viewed that as exceedingly unlikely (4%), and assigned “0%” to the 14th Amendment idea.

I doubt there’s much utility in walking through the details of Yellen’s bad options again. Or at least not until another week goes by without a deal. Instead, I’ll just make a few additional points.

First, with a little luck, it’s possible Yellen could make it through next month. But, as Goldman wrote, “even if the Treasury believes it is more likely than not to have sufficient cash, even a low probability that it could deplete resources would probably keep the deadline in early June.” The last thing Yellen wants is to give lawmakers an excuse to procrastinate and engage in more brinksmanship.

Second, the ratings agencies probably won’t downgrade the US absent a missed interest or principal payment, which Goldman (correctly, in my assessment) views as exceptionally unlikely.

Finally, markets other than T-bills won’t care until they have to. That’s especially true of stocks. “While some corners of the financial markets are pricing in debt limit-related risks, the effect on the equity market as a whole appears modest,” Phillips and Krupa wrote. “This is likely in part due to the fact that market participants assume a deal will happen until they have a clear reason to change that assumption.”

Following the GOP walkout Friday, Karine Jean-Pierre said there were still “real differences” between the two sides, even as Biden was confident in a path forward.


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11 thoughts on “What Janet Yellen Sees As Debt Limit X-Date Looms

  1. “could affect Social Security, Medicare and other benefit programs”

    If the above happens,
    1. The heat on the political players will be like lava.
    2. The lava will flow well before coupons or principal are missed.

  2. I’m not sure how easy this is from a logistical standpoint, but instead of missing ALL Social Security, Medicare, and other payments, just miss those in Republican districts. It could extend the X-date (especially if it was started now) and would put a ton of pressure on Republicans in those districts.

        1. Upon further thought, some people get Social Security, beginning of the month others the middle. They could just change it to everybody end of the month. Most young people I talk to are fed up with baby boomers so I don’t think it’ll affect democrats base as much.

    1. If federal operations and payments have to be stopped, Biden wants Republicans to get the blame, which means he can’t be seen as actively targeting particular states or voters (and that’s not him anyway).

      Voters will understand protecting the national defense and debt above all else. They will expect that politically sacred benefits like SS and Medicare be protected as much as possible. Biden will want to shut down so-called non-critical government functions (national parks, etc), then increasingly critical functions (federal funds for education, transportation, social programs, etc), finally getting to the most critical parts (TSA, FAA, SS, Medicare, etc). Analogy to the body shutting down peripheral systems and senses as it approaches death – and he should use that analogy, voters will “get it”.

      The pressure on Congress as this process unfolds will be incredible.

      House Dems only need a handful (5? 7?) of Reps to cross the aisle – or a few more to abstain – to pass a no-strings debt ceiling bill.

      There have been federal budget/debt impasses before. They have all been resolved by the White House shutting down layers of the federal govt until Congress cries “Uncle”.

  3. I don’t understand why the White House must negotiate with extortionists. The is a crisis manufactured by the Republicans. They are making demands while threatening to tank the economy if the other side fails to comply.

    1. They are threatening to tank the US position as financial world leader. They are also threatening collateralized loans, the dollar and much else. The last time this happened in earnest the US lost its AAA credit rating, something that raised costs permanently. Another cut in rate will add more to interest costs for years. Are there any adults in this amateur circus now serving as our Congress? I can’t see them. Won’t their moms all be proud?

  4. I still think the most likely scenario is what I’ve mentally been calling, “Extraordinary extraordinary measures.” That could be any number of Janet Yellen’s bad options, from minting a trillion dollar platinum coin to invoking the 14th amendment. This would also include paying off Treasury securities while not paying for anything else–anything short of total “default.” Goldman Sachs disagrees though, and I’m humble enough to admit they’re more knowledgeable than I.

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