Earlier this year, the U.S. Treasury bumped up against this borrowing limit and began implementing “extraordinary measures” to conserve cash. Those emergency measures have nearly run out, and now the Treasury is faced with the risk that they will not have enough cash to pay the bill, which Congress has already appropriated.

We remain optimistic that a fiscal agreement will resolve the matter, as political leaders are clearly very engaged. Moreover, our analysis suggests the Treasury Department has fudged the deadline such that negotiators have much more time than publicly acknowledged. Nevertheless, the late hour does pose risks for a “technical” default (i.e., delayed payment) on maturing Treasury bills or notes. For the bond markets, there are hard-to-measure liquidity and operational risks that would emerge from any missed payment, but the potential consequences for the economy remain the worse problem.

What Investors Could Do

T-Bills coming due in the first weeks of June are at the highest risk of delayed payment, in our view, and any holders with significant liquidity needs should be cognizant of that risk. There is no reason, however, to avoid money market funds (MMFs). Even all-Treasury MMFs have large portions of their assets in “repurchase agreements” facing the Federal Reserve and other counterparties that come due every night. As a result, even in the case of missed payments on a few MMFs’ T-Bills, they will still have plentiful liquidity from other sources to cover any needs.

Chart 1: Among Large Government MMFs, T-Bills Average 10% of Assets

Treasury Secretary Janet Yellen recently wrote to Congress warning that it is “highly likely” that the Treasury could fall short on cash. As of May 23, the Treasury held $63 billion in cash in its Treasury General Account (TGA). Making matters more complicated, June tends to be a month with big swings in cash balances. On June 15, the TGA will see corporate tax payments of around $85 billion. Assuming the TGA has enough cash to cover payments through June 15, there would almost certainly be enough to sustain cash balances until the end of June, when an additional $250 billion becomes available and lasts the TGA through mid-August. Our conclusion is that, while cash balances are critically low, if the Treasury can squeak through to June 15, there’s more time available for a negotiated solution.

Chart 2: Treasury General Account Cash Balances Have Dwindled to $62B

What a Deal Might Include

Janney’s Investment Strategy Group does not have any special insight into negotiations, but from public statements and political insider research, it appears legislative leaders are working in good faith to shape a deal. While time is tight, there is still room, and we suspect such a deal will include the following:

• an extension of the debt limit until late-summer 2024 (which means the next vote on the issue can wait until after the 2024 elections),
• spending caps on a range of discretionary categories that limits growth, but does not outright cut (and which future Congresses can reverse),
• a commission on additional spending cuts and tax hikes (much like in 2011), and
• energy-permitting legislation (which is a priority for the Republican leadership and acceptable to a wide range of centrist Democrats).

In Case Negotiations Fail

Although we remain optimistic about the odds of a negotiated solution, we would be remiss to ignore the downside risks posed by failure. Those risks come in two broad areas: financial markets and the real economy.

Chart 3: Ratio of Government Debt to GDP Has Actually Declined Since Summer 2020

First, no reasonable market participant thinks the U.S. will “economically” default on its debt. There has never been a missed Treasury payment in the contemporary era, save for a quickly resolved clerical error in 1976. The government has plentiful economic capacity, and the ratio of debt to GDP has, contrary to popular perception, declined since 2020. In effect, the market interpretation is that, in an extreme scenario in which the Treasury misses bond payments, those payments will be made up soon after. There is no cross-default provision in Treasuries, meaning that a missed payment on one bond does not affect others. Moreover, the U.S. government cannot be sued for bankruptcy, which is what typically happens when a company misses a debt payment. In that sense, the primary risk is a delayed payment rather than a default, and the risk is greatest for Treasury bills or notes that mature around the time the TGA runs critically low on cash. There is no reason to think that missed payments will accrue interest, so for holders of defaulted T-Bills, a further downside is lost interest income through the delay period.

Second, it is impossible to suss out the operational or logistic impact of a missed payment. Treasury obligations “live” on and payments are processed through something called Fedwire. Fedwire is simple, flexible, and operationally robust. But over many decades, banks and asset managers have layered their own internal systems on top of Fedwire, creating a weird tapestry of operational systems. It is not clear how these systems would manage a missed payment—for example, some broker/dealer system might automatically forward the payment to another entity, leaving that bank temporarily short the payment.

Another asset manager might attempt to use a defaulted T-Bill as collateral for an overnight loan, and if its lenders won’t accept the collateral, the manager could face financing problems. In some ways, this operational situation is like Y2K risks from 20-odd years ago. There probably won’t be any major problems, but there is a small chance some will emerge and be messy to untangle. In our view, the bigger implications from the current debt-ceiling negotiations will be economic. The federal government touches about 7% of the U.S. economy directly, and much more indirectly. Secretary Yellen maintains that the Treasury Department cannot prioritize payments for practical reasons and so missed payments on debt will probably also mean missed payments to the real economy.

In the event the TGA runs low on cash, it is conceivable that the Treasury could pay contractors, federal employees, and even Social Security recipients in IOUs. That will force some cohort of the economy to slash their own spending, resulting in lost jobs across a range of sectors. Even the prospect that the federal government might pay out in IOUs could force potentially affected consumers to hoard cash, thereby triggering a short-lived economic contraction. In the intermediate term, even in the event of a “successful” debt-ceiling deal, there’s a good chance we will see reduced federal spending. Any reduction will have a negative impact on real economic growth and jobs at a time when many areas of the economy also face risks. Future Congresses could well reverse cuts, but they will have at least some impact in the meantime.

Summary

We remain optimistic that Congressional and Administration negotiators can reach a compromise deal to suspend the debt ceiling in exchange for some modest spending cuts.

In the event the Treasury does run low on cash, missed T-Bill maturity payments are the most obvious short-term risk, and there are substantial operational complexities that could result. Intermediate term, the real hostage is not bondholders, but rather the U.S. economy, which faces downside risks from missed or even hypothetically missed payments to businesses, employees, and federal-benefit recipients.