On Friday, BlackRock published an update on the debt ceiling and its possible impact on money market funds, entitled, "Raise the Roof? The Return of the Debt Ceiling." Their description says, "With the U.S. government facing a deadline in late September/early October to raise the debt ceiling or face a possible default/downgrade, BlackRock Global Cash Management has prepared the attached paper discussing our latest thoughts and insights on the issue. We also discuss the associated impacts on the liquidity markets and your cash investments with us." (See also our August 30 News, "Treasury Default, Debt Ceiling Concerns Loom; Problem for Govt MMFs?")
The report explains, "Without legislative action the U.S. government could experience a technical default and/or sovereign ratings downgrade. Complicating matters is the threat of a government shutdown at the end of the fiscal year, September 30, due to Congressional division over approved budget bills that authorize federal spending. The debt limit and government shutdown are distinct and separate issues but are being linked together as a function of timing."
It tells us, "Despite the recent political turmoil over the debt ceiling, Congress has always acted in time and protected the full faith and credit of the United States. Today, Congress is facing the challenge to raise both the debt limit authority and pass the fiscal year budget with just 12 Congressional working days scheduled for September. In spite of these demands, BlackRock's view remains that both issues will be resolved in a timely manner."
BlackRock writes, "Debt ceiling episodes typically have had the largest impact on the U.S. Treasury Bill ("T-Bill") market. So far, anxiety regarding the current debt ceiling showdown has been contained to T-Bills with October 2017 maturities. Based on the timelines discussed above, we believe the market has deemed October T-Bill maturities to be the most vulnerable to potential technical default and delayed payment risks."
They state, "As a result, the T-Bill curve is currently inverted for October maturities with yields on these issues trading approximately 10-20 bps higher than T-Bills maturing around these October dates. In our opinion, this dynamic represents risk aversion on the part of market participants and expectations that a resolution is likely to be fraught with political risks."
BlackRock's paper tells us, "In past debt ceiling episodes, T-Bill market anxiety appeared roughly a month prior to the X-Date. However, relative to this episode, October T-Bill maturities began underperforming in July as we believe market participants appeared to begin factoring in Congress's recent inability to pass legislation, a more concentrated government money market fund footprint and more restrictive balance sheet environment for banks and broker/dealers."
It explains, "In previous cycles, T-Bill outstandings declined into debt ceiling dates in order for the U.S. Treasury to comply with statutory borrowing limits and provide headroom for Treasury coupon settlements.... Shortly after the debt ceiling is resolved, the U.S. Treasury is expected to materially increase T-Bill net issuance to replenish its operating account towards its targeted size of $350-$500 billion. The rebound in T-Bill issuance could total $350 billion in the 4th quarter according to the U.S. Treasury's quarterly refunding announcement and could place upward pressure on front-end Treasuries and repurchase agreement rates."
On a possible ratings downgrade, they comment, "A number of the major ratings agencies have published reports on the potential for delayed payment on U.S. debt as a result of the debt ceiling. In our opinion, Fitch Ratings appears to be taking the most assertive stance stating that hitting the X-date may not be compatible with the current "AAA" rating on the sovereign, even if prioritization of payment may avoid a default. Moody's Investor Services ("Moody’s") analysis is focused specifically on the risk of default on U.S. government debt obligations. If the X-Date is crossed, Moody's expects the government would opt for prioritization of interest payments, which would not be explicitly viewed as a default and is therefore unlikely to have an immediate impact on the current "Aaa" rating of the U.S. government."
The piece adds, "Although it may seem like deja vu to be discussing and managing the debt ceiling and associated political log-jam once again this fall, this episode is shaping up to be somewhat different from the 2011, 2013 and 2015 events in large part because of the turmoil within the current administration in Washington and severely divided state of Congress. BlackRock takes the view that legislative risks around debt ceiling episodes should be respected and factored into portfolio strategies. To that end, BlackRock re-formed the Debt Ceiling Task force, first launched in 2011, to centrally coordinate firm-wide management and contingency planning around debt ceiling impasses."
Finally, they say, "Additionally, BlackRock's Government Money Market Fund platform has taken the following steps: Materially reduced the platform's exposure to very early October T-Bill maturities; Managed down exposure reductions to mid-October Treasury securities; Rebalanced Treasury collateral exposure, within our repurchase agreement transactions, that we deem vulnerable to potential delayed principal payment in the event the X-Date is crossed. While these planning initiatives are consistent with our approach to liquidity, BlackRock remains confident that a default on Treasury debt obligations by the U.S. Treasury is a very low probability outcome. We continue to closely monitor the situation for updates and seek to manage our exposures in a conservative manner. We will continue to keep you informed as the situation unfolds."
