Despite the GOP’s tax reform victory, over the past few weeks, Congress once again punted on a formal decision how to keep government funded and what to do with America’s debt ceiling and as a result US legislators simply kicked the can on the agreement of raising the nation’s borrowing limit for another few months. However, with the Treasury expected to breach the ceiling as soon as late March, today’s $45 billion 3-Month Bill auction was closely watched as it serves as a fresh gauge of investor anxiety about the ongoing impasse.
As a reminder, in the first week of December, the Treasury deployed a series of extraordinary measures to stay under the debt ceiling cap since it was reinstated on December 8. But T-bill investors, in both the primary and secondary market, remain especially wary given questions over what’s known as the debt ceiling’s drop-dead date. Today’s Bills mature March 29, within the Congressional Budget Office’s late-March to early-April window for when Treasury will exhaust the extra capacity it’s using to keep below the $20.5 trillion limit.
Quoted by Bloomberg, Justin Mandeville of Inveso said that the late-December bill auctions “speak volumes to investors being cautious as to when the potential drop-dead date will be,” adding that “we saw it back in July when we had concerns about the October bills.”
And sure enough, having just concluded, the 3M bill was especially ugly, pricing at 1.445%, or a 3bps tail to the 1.415% When Issued, with Indirect Buyers fleeing, and taking down just 20.1% of the finally allotment, down from 30.8% in the last 6 auctions, while Primary Dealers had no choice but to step up aggressively from 61.9% in the 6MMA, to 74% as Direct interest also fizzled from 7.3% in the last 6 auctions to just 5.9%. But nowhere was the revulsion quite so visible as in the bid to cover, which plunged from 3.04 in the past 6 auctions to just 2.71 on Dec. 26: this was the lowest Bid to Cover since January 2009.
As Bloomberg reminds us, at the government’s July 24 auction, the US Treasury sold $39 billion of three-month bills at 1.18 percent, then the highest rate since 2008. The bid to cover for that particular sale also matched the lowest for the maturity since 2009. Congress wound up passing a three-month debt-ceiling suspension Sept. 8, weeks before Treasury Secretary Steven Mnuchin estimated the government would run out of cash.
However, revulsion to paper that could be impacted by the debt ceiling was not just in the primary market: it also hit the secondary Bill market, as the previously noted kink that has emerged in the bill curve between securities maturing in late March and those in early April, has gotten even more pronounced. For several days after the Dec. 18 auction of bills maturing March 22, the rate on these securities was higher than debt maturing a week later. Since then, the rate on securities expiring March 29 has climbed to 1.44%, exceeding those on bills due the following week by nearly 10 bps as shown in the chart below.
And so, looking at the debt ceiling fight that refuses to go away despite the can being kicked every few months, while there is still a chance the issue could be resolved without going down to the wire, it is unlikely: while lawmakers hammered out a spending bill this week to keep the government open through Jan. 19, they didn’t include a provision to lift or suspend the debt ceiling. The longer a resolution remains at the bottom of Congress’s to-do list, the larger the T-bill dislocations could grow. Sooner or later, the bond market – which has been crying wolf on a technical US default – will eventually be right.