Morgan Stanley Investment Management posted a piece entitled, "Taking It to the Limit," which tells us, "The U.S. government is progressing towards exhausting its borrowing capacity and available cash in October. The market is beginning to take heed of the approaching legislative brick wall after sleepwalking through most of the summer. Recent headlines have focused on political wrangling in Washington with numerous ongoing battles, including the infrastructure package, federal budget, and the debt ceiling. Investors are beginning to focus on the potential for partisan political brinkmanship and the looming debt ceiling debate to introduce volatility into the markets, first showing up in the Treasury bill market, and perhaps spreading to other areas." (Note: Thanks to our excellent speakers and sponsors and to those who attended our Money Fund Symposium in Philadelphia this week! Watch for the recordings to be posted early next week and for excerpts in coming days.)
They write, "The debt ceiling, which is the U.S. borrowing limit set by Congress, has proven to be a market moving event in the past, most acutely in 2011 and 2013. Several market strategists have noted that the political climate in 2021 has similarities to a decade ago. Generally, when the debt ceiling comes up for extension, it is an unpopular and politically divided discussion, typically met with resistance by the minority party in Congress. Historically, expectations are and always have been that ultimately the debt ceiling will be resolved. But while the discussions linger, pushing the debt ceiling closer to the limit could invite substantial market volatility. Below we discuss the key areas to watch as this process continues."
Morgan Stanley explains, "The debt ceiling suspension expired on July 31, 2021 and the Treasury Department has been using extraordinary measures, as it has done in similar circumstances in the past, along with cash inflows, to finance government activities. Currently there is considerable market uncertainty surrounding how much longer the Treasury can continue to operate under these extraordinary measures before resulting in a technical default. If the Treasury reaches the point of exhausting these extraordinary measures, it could result in a technical default and/or a delayed payment by the U.S. Government."
They explain, "The effects of a technical default on money market funds are not prescribed. There is no guidance from SEC Rule 2a-7, which governs money market funds, or the rating agencies as to how money market funds are required to react to a potential default in U.S. Treasury securities. There is no explicit rule that forces money market funds to sell Treasury securities if they default. The responsibility lies with the fund board of directors and the portfolio managers to determine the best course of action for the portfolios. Against this backdrop, we think the best way to avoid this potential overall impact is to dynamically address the one factor that we as portfolio managers can control -- portfolio positioning, keeping in mind that the 'X date' is a moving target."
MSIM states, "The Morgan Stanley Liquidity Funds do not hold any positions in absolute Treasuries with October or November maturities, those deemed to have the highest potential default or delayed payment risk. The risk/reward in owning these Treasuries is not compelling from both a potential default or yield perspective."
They add, "Over the course of the summer, as Washington failed to address the debt ceiling and the political rhetoric began to increase, we proactively sold off these Treasuries when the market was not pricing in any concern surrounding the debt limit. Eliminating these exposures had a very minimal, if any, yield impact to our Portfolios given the extremely flat yield curve and reinvest environment. Compared with prior debt ceiling episodes, most of our funds have held more Treasuries on both an outright and percentage basis as part of our asset allocation given the significant debt issuance related to the government stimulus packages over the past year."
The publication says, "We felt taking this preemptive action diminished the potential illiquidity of Treasuries near the 'X date' and underscored our conservative, thoughtful, and proactive philosophy around portfolio positioning. The objectives of a liquidity investor revolve around capital preservation and liquidity and taking steps like this to avoid headline risk and potential market volatility is a key to achieving these goals."
Finally, Morgan Stanley writes, "Headlines on the debt ceiling will likely continue to proliferate so this is a good reminder for investors to evaluate their holdings in Government and Treasury money market funds to understand fund positioning and any potential exposure to Treasuries maturing in October and November. Morgan Stanley Investment Management's Liquidity team is committed to assisting you in evaluating treasury management and liquidity landscape and developing solutions tailored to your unique objectives. We look forward to helping you tap into our unique blend of expertise and resources."
For more, see these Crane Data News articles: "FT Writes on Debt Ceiling Battle, Impact on T-Bills and Money Funds (9/2/21), "Another Silly MMF Article from FT; Swirsky on Debt Ceiling Lessons" (11/25/13), "Fitch on Fed's Reverse Repos, Bank Support; Wells on Debt Ceiling" (11/13/13), "November MFI Features Debt Ceiling, JPMAM's Donohue, Portal News" (11/7/13), "MMF Assets Surge Following Debt Ceiling Resolution; ICI Blasts FT" (10/25/13), "MMFs See Big Outflows Prior to Debt Ceiling Extension; ICI's Reid" (10/18/13), "ICI, Stevens, Fitch Comment on Debt Ceiling Issues and Treasury MMFs (10/10/13), "October MFI Features Comment Letters, Fidelity's Prior, Debt Ceiling" (10/7/13), "ICI on S&P Downgrade, Reviews Flows During Debt Ceiling Debate" (8/8/11), "Fidelity's Huyck Comments on Debt Ceiling Countdown, Answers FAQs" (8/1/11), "More Debt Ceiling; Reuters Quotes Shapiro on Floating NAV, Europe" (7/22/11), "ICI's McMillan and Reid on Debt Ceiling Scenarios and Impact on MMFs" (7/21/11), "Invesco on Understanding the Debt Ceiling Debate and Money Funds" (7/13/11) and "Federated's Sue Hill Says Don't Sweat The Debt-Ceiling Showdown" (7/20/11).
