EXPLAINER-What a U.S. debt ceiling extension means for bond markets

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NEW YORK, Oct 12 (Businesshala) – Gridlock at the US debt limit has been temporarily resolved, but a long-term solution has also been postponed. Last week’s ceasefire cheered the bond market a bit, but investors are still eyeing default risks ahead of the new December deadline.

What is the loan limit now?

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After weeks of wrangling, the US Senate here approved an extension of the debt limit, raising the maximum amount the US government can direct to meet its financial obligations from $480 billion to $28.9 trillion now. It now goes to vote in the US House of Representatives on Tuesday before being signed into law by President Joe Biden. It is expected to meet the debt financing needs by at least the beginning of December.

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Analysts said this would give Congress more time to pass a longer-term debt limit extension through conciliation. BofA Securities said in a research note that it believes US Treasury funding could move beyond December and into January or February.

What does the US Treasury need to pay for the increase in the debt limit?

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About two-thirds of the US Treasury’s $480 billion new lending authority is expected to be spent soon. Money market research firm Wrightson Capital said in a research note that the Treasury must, by law, restore trust fund balances that were disinvested during the “suspension period of debt issuance” (DISP). The Treasury’s latest weekly debt limit activity report showed last Friday that government trust funds owed $301 billion in non-marketable securities as of October 6. Wrightson said converting those trust fund securities would leave the Treasury with less than $200 billion to the traditional lending authority. The loan limit hike will be officially effective later this week.

If $480 billion is exhausted, will the Treasury still be able to use extraordinary measures?

Wrightson’s projections suggest the Treasury could use up the rest of its regular borrowing by the first week of November. If so, Treasury Secretary Janet Yellen may have to announce a new DISP, which will allow the department to tap into its extraordinary measures again. Wrightson said this gives the Treasury about $300 billion of accounting flexibility, which should be enough to cover all of its borrowing needs for the rest of the year.

Will the supply of Treasury bills increase with the increase in the credit limit?

Bill supply could increase by more than $300 billion after BofA Securities projects short-term debt limits are signed into law. This estimate is based on the Treasury’s current and targeted cash balances. The bills will likely take the form of one month and short-dated cash management bills.

What are the near-term market implications of credit limit expansion?

As a result of the extension, the risk of a short-term loan default is reduced if it is not deferred to December. A one-year credit default swap will pay off in case of a US government default that traded at 14.9 basis points last Friday, after rising to 28 basis points prior to the increase in the loan limit.

Yields on US bills with maturity at the end of October also declined. For example, yields to maturity on October 26 fell to 4 bps last Friday, up from about 20 bps last week. However, the pressure has shifted to maturity in early December, where returns have doubled. Yield to maturity on December 7 rose to 8 bps last Friday from 4 bps a week ago.

Outside the bill market, however, there are some signs of tension. In the US repurchase (repo) market, investors are keeping a close eye on Treasury bill collateral given to them in overnight and term trades. Barclays wrote in a research note that when lenders are looking at loan limit-sensitive CUSIPs, or identification numbers, they have not excluded them from the eligibility list. This suggests some hope of debt ceiling resolution.

Reporting by Gertrude Chavez-Dreyfus; Editing by Megan Davis and Paul Simao

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