David Randall, SaqibIqbal Ahmed, and Gertrude Chavez – Dyfuss

NEW YORK (Reuters), Investors begin to be worried about the debt limit as Congress closes in on the deadline to raise the U.S. borrowing cap to avoid a historic default.

Two weeks prior to Oct. 18, President Joe Biden stated Monday that he could not guarantee that the government would not exceed its $28.4 Trillion debt limit, unless Republicans and Democrats vote for an increase.

Market sentiment is deteriorating in short-term bills and credit default spreads regarding U.S. debt. Janet Yellen, U.S. Treasury Secretary has stated that the government would run out of money by the end of the year unless Congress increases the ceiling on federal debt.

Arthur Hogan is chief market strategist for National Securities Corp. He stated, “The debt ceiling, infrastructure talks out (Washington), D.C.), will continue to remain front and center this week amid additional hints that rating agencies could take down the U.S. Credit rating a bit if the drama continues.”

SHORT-TERM TREATMENT SPREADS

Tension is evident in the Treasury bills market with 1-month bills being affected by potential defaults yielding more than 3-month bills.

One-month bills yield 0.1%. This is close to the highest level since March, on an intraday basis. Three-month bills yield 0.038%. Since March 2020, the spread between three-month and one-month bills has been widest.

Portfolio managers avoid billing issues that could lead to default, even though the chance of an unpaid payment being made is low. It can lead to higher yields for some debts than the ones on older issues, which is a rare occurrence on the upward-sloping yield curve.

Graphic: U.S. debt ceiling stress , https://graphics.reuters.com/USA-ECONOMY/DEBT-CEILING/byprjldaape/chart.png

U.S. REPO MARK

Other than minor volatility, there have been no signs of stress in the overnight U.S. repurchase agreement market (repo).

The overnight repo rate on Monday was 0.05%. Traders said that there was some volatility in the past few days. Overnight repo rates were as high at 0.07% last week but as low as 0.1% this week.

With the U.S. Treasury expecting to draw down its cash balance by the deadline for the debt ceiling, rates of repo have been volatile. The excess funds are now flowing into the banking system and designated reserves. The Federal Reserve’s reverse repo facility allows banks to either invest in the repo markets, pushing rates down, or loan to them. It takes some money out of the repo market, but tends to raise overnight rates a bit.

“Except maybe some elevated volatility,” Dan Belton of fixed-income strategist at BMO Capital in Chicago said.

Inflows by government agencies such as Fannie Mae can also affect the rates in the repo markets at specific times of the month. Freddie Mac (OTC).

The volume of the Fed’s repo window rose to $1.604 trillion last Thursday as investors flock to the U.S. central banks facility, where they receive an assured 5 basis for overnight liquidity without counterparty risk.

Graphic: U.S. repo market and debt ceiling, https://fingfx.thomsonreuters.com/gfx/mkt/movankrexpa/Repo%20market%20and%20debt%20ceiling.PNG

OPTIONS MARKKET

Investors who are worried about an event in the future tend to buy options hedges. This increases volatility.

Option on and its tracking ETF expire on October 15, right before the debt ceiling deadline. They have a bit more volatility than contracts that expire prior and/or after them.

Investors are paying more attention to the Debt Ceiling Showdown if there is a significant increase in volatility around expirations in the coming days.

Graphic: Equity volatility term structure, https://graphics.reuters.com/USA-MARKETS/egvbkygrbpq/chart.png

CREDIT DEFAULT SWAPS

The value of thinly traded creditdefault swaps which would be able to pay out in case of default by the U.S. government have increased in recent times, but they still remain below the level they traded in summer 2011, when debt ceiling talks led to rating agencies downgrading U.S. bonds.

According to Refinitiv data credit-default swaps for one year are currently trading at the levels they last saw in December 2020. However, they remain 40% below the March 2020 level when most of the U.S. economic system was shut down during the initial stages of the coronavirus epidemic.

Graphic: U.S. sovereign debt credit risk, https://fingfx.thomsonreuters.com/gfx/mkt/zjpqkjbojpx/Pasted%20image%201633373787862.png

MONEY MARKET FLOWS

Investors sent $33 billion to money-market funds in a sign of growing nervousness during the week ending Sept. 29. According to the Investment Company Institute, this move towards cash saw the money market’s total assets rise to $3.9 trillion. This is the highest level since June.

Graphic: Money market assets increasing as debt ceiling deadline nears, https://graphics.reuters.com/USA-FUNDS/DEBTCEILING/jnvweyneovw/chart.png