Debt Ceiling Part II

Author: David R. Kotok, Post Date: August 29, 2017

Bullets on the debt-ceiling charade:

1. No one expects the US to default. So why has the credit default swap (CDS) on the US risen in price? Answer: Bond market agents want to add a little insurance just in case American politics deliver a negative surprise.

2. The short end of the US Treasury curve is distorted by the charade. Market agents seek Treasury bills that mature beyond the October crunch date, so they can avoid a whipsaw.

3. US Treasury normal year-end cash balance is expected to be $350–$400 billion. That is what it was in the previous year. Debt-ceiling politics are likely to take September cash under $100 billion and falling.

4. October is the crunch month. Will Treasury miss the October debt-service payment? No.

5. Will 50 million Social Security checks be delayed? No.

6. At the last minute Congress will come up with temporary extensions to avoid a default. All the political statements and posturing are just that and nothing more.

7. Total costs of this charade of debt-ceiling politics are estimated between $75 billion and $200 billion. We use the lower number by estimating the additional CDS cost effect on all US dollar-denominated debt including derivatives. Thus each basis-point rise equates to about $15 billion at an annualized rate based on a debt and derivatives aggregate estimate of $150 trillion. Note other methods use secondary effects to achieve a higher cost estimate.

So who pays and who gains? All governments at all levels from local school boards to US Treasury incur direct costs or opportunity costs. All savers using banks get paid less because banks receive the cash when Treasury runs down its balances, and therefore banks pay savers less interest on their savings because they have an abundance of deposits.

Who gains? No one. This a societal cost. Congressional Democrats and Republicans collectively impose the cost by their behavior. Don’t blame President Trump for this one; his Treasury Secretary, Mnuchin, is complying with the law and is asking for a clean debt-ceiling increase.

Our proposed political solution will never pass. It is that all members of the House and all Senators and all their staffs and committee staffs be the first to take cuts in pay. Furthermore, we would make such pay cuts permanently conditional. Any time US Treasury balances are below $100 billion, don’t pay the federal legislature or their staff.

Will this solution become law? No. They will never vote to discipline themselves.

Will there be bond market gyrations because of this charade? Yes. We already see them.

When the charade has run its course, will bond markets resume focus on central banks, inflation, growth, credit demand, etc? You bet.

But between now and then, for a few months, politics in the US Congress will impose higher volatility and higher costs on all of us.

Sign up for our FREE Cumberland Market Commentaries

Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets.  Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.

cumber map
Cumberland Advisors® is registered with the SEC under the Investment Advisers Act of 1940. All information contained herein is for informational purposes only and does not constitute a solicitation or offer to sell securities or investment advisory services. Such an offer can only be made in the states where Cumberland Advisors is either registered or is a Notice Filer or where an exemption from such registration or filing is available. New accounts will not be accepted unless and until all local regulations have been satisfied. This presentation does not purport to be a complete description of our performance or investment services. Please feel free to forward our commentaries (with proper attribution) to others who may be interested. It is not our intention to state or imply in any manner that past results and profitability is an indication of future performance. All material presented is compiled from sources believed to be reliable. However, accuracy cannot be guaranteed.