CAG: Cash Portfolios & the Debt Ceiling
Capital Advisors Group published, "How to Position Corporate Cash Portfolios for the Debt Ceiling Showdown." They tell us, "Once again, it's time for CFOs and corporate cash investors to start focusing on another debt ceiling showdown in the United States Congress. On May 1st, 2023, Treasury Secretary Janet Yellen updated Congressional leaders that the United States would not be able to pay all its bills by June 1st, 2023. Secretary Yellen had previously informed Congressional leaders on January 19th, 2023, that the U.S. government had reached its statutory debt limit of $31.381 trillion, and a 'debt issuance suspension period' began during which the Treasury Department started using 'extraordinary measures' to keep the U.S. government funded through June 5th, 2023.... Secretary Yellen's letter was a significant development to the debt ceiling fight, as market participants had expected the U.S. government to make on time payments to all recipients until late summer or early fall 2023.... We believe that politicians will again come to their senses and authorize spending in time. But, if they should fail to reach an agreement, the Treasury Department may work with the Federal Reserve to prioritize payments on debt obligations to avoid a default, though this would not be without operational complexity. These 'extra-extraordinary measures' would most likely be temporary and politically distasteful but might create an additional incentive for Congress to authorize new spending limits. Nevertheless, given the high stakes and high degree of conflict in Congress this time around, liquidity investors are well-advised to pay attention." Author Lance Pan explains, "CFOs and institutional cash investors have tools at their disposal to contend with possible consequences of the current debt limit showdown. Reviewing past playbooks and coming up to speed on the details of the situation today -- especially looking past headline risk toward the possible timing of the default X-date -- can help investors position their portfolios for this year's uncertainties.... Knowing the X-date is important for CFOs and other managers responsible for corporate cash investments and liquidity. However unlikely, a delayed bond payment on the stated maturity date may result in bond maturity miss-matches in portfolios in relation to monthly or quarterly cash withdrawal estimates. For this reason, cash managers may prefer to avoid holding securities that mature around the X-date to minimize liquidity impact and operational difficulties. This is also why Treasury securities that mature around the X-date tend to see their yields rise, which move in the opposite direction to prices. All else being equal, one strategy to avoid the X-date is to consider selective investments in high-quality securities with longer maturities in order to avoid missed coupon and/or maturity payments from US Treasury securities." He adds, "We believe liquidity investors may benefit from following strategies that worked in previous debt ceiling episodes. They should not be overly concerned with the headline risk but instead monitor the timing of the X-date and allocate their liquidity targets accordingly. Although we are confident (but not blindly so) that the debt limit will be lifted in time and a default avoided, we recommend that investors consider a liquidity portfolio with laddered maturities and high-quality credit instruments, as market liquidity may be choppy as investors process the highs and lows of the negotiations.... Liquidity investors should review their portfolios with their investment advisors, repurchase agreement counterparties, and money market fund managers to limit exposure to securities with at-risk maturities, and refrain from buying securities with elevated yields near the X-date. Cash investors generally prefer to avoid holding securities facing delayed maturity payments. Since Secretary Yellen's estimate for the X-date is significantly sooner than earlier market projections, some liquidity portfolios, including money market funds, may own securities in this time window. As discussed earlier, a delayed maturity payment is a curable liquidity situation, not a credit event, as the U.S. government's ability to honor its obligations is never questioned. To the extent an investor does not rely on these securities for immediate liquidity, it may be prudent to hold on to them as the baseline outcome remains that the debtholders will be made whole."
