Do Rates Care About Debt Ceiling?

It was nearly impossible to avoid the news about the debt ceiling this week, but how much does it really matter?

Let’s make sure we’re on the same page first. What follows are some non-political views on the debt ceiling, which is different from “default”.

The US government has to raise the debt limit from time to time in order to borrow enough money for day-to-day operations. Theoretically there is a point where the government does not have enough money to pay what it has already agreed to pay. That money can come from Treasury debt issuance (i.e. borrowing) or from sources of revenue (i.e. taxes).

In that theoretical scenario, the US could default on its obligations and that would be incredibly serious. For example, a missed payment on Treasury bills can cause a large decline in financial markets. This has never happened and it is guaranteed not to happen this time either. We can’t know for sure how long it will take if the government actually has to meet its needs, but it’s certainly longer than is being claimed, even if you listen to someone in the news. Can also see the drop dead date.

That leaves us with something that is mostly political theater and/or bickering on both sides of the aisle (no value judgments in this newsletter). Despite this, some traders take logical, defensive measures, just in case we finally see a default (even if it is very temporary and highly qualified).

Those defensive measures create volatility in some parts of the bond market that spreads to other parts of the market. Additionally, the broader theme of debt ceiling is generally negative for riskier assets such as stocks and positive for longer-dated bonds. Conversely, when a deal is announced, bonds may take a hit, thus pushing rates up even more.

From a more practical perspective, a debt ceiling deal would restore the US government’s ability to borrow money through Treasury issuance, and Treasury issuance is directly related to interest rate levels (more issuance = higher rates, all other things being equal). is related with.

All this is happening at a time when rates are already under pressure to go up. For example, mortgage rates rose more than 7% this week for the first time since early March.

This has nothing to do with the debt ceiling and everything to do with the economy and the stable message from the Federal Reserve. To be fair to the Fed, their message will depend on inflation and the economy, and the Fed’s response has been consistent: calling for rates to stay high until inflation is clearly moving back toward the 2% target. Needed. And here are the inflation indices the Fed would like to see at 2%:

Inflation may have eased, but it has been frustratingly reluctant to decline in any meaningful way. Some say it is coming. Others say it will take longer than most people think. All the Fed can do is continue to wait for clear signals from the data, and the data has not been generally favorable to rates in the second half of May.

Futures traders now see only a 1 in 3 chance of the Fed holding steady at the June meeting in several weeks. Expectations for a rate hike with longer-term rates have been steadily higher.

After markets close on Monday for the Memorial Day holiday, both market participants and the Fed will be treated to 4 days of economic data that will imbue the rate outlook with more power than anything we saw this week. Impressed. Chief among the upcoming reports is next Friday’s big jobs report. After 2 weeks, the next installment of the Consumer Price Index (CPI) will come just before the buzzer on June 13th as the Fed begins its 2-day policy meeting that is likely to result in a rate hike decision on June 14th at 2PM ET.

A CPI report isn’t enough to determine whether the Fed has finally reached the “pause” phase of this rate hike cycle, but it certainly could decide at this meeting (if next week’s data leaves any doubt). leaves anything for, and maybe it will be).

Bottom line: Rates have gone up for real economic reasons and they could go higher if those reasons show little sign of reversal.