Debt-limit default spells Treasuries nightmare in US

Bloomberg

Nobody doubts America will make good on its debts.
Yet if Congress fails to lift the debt ceiling in time, what’s known as a “technical” default— one that merely delays interest and principal payments— would be on deck for the $14.1 trillion Treasury market, presenting a potentially dizzying array of complications.
Bond-market industry groups aren’t waiting to see how it plays out. They’re fine-tuning prior blueprints for how to handle affected securities so trading is uninterrupted and the plumbing of a crucial market for short-term financing still functions.
Still, nailing down the back-office preparations doesn’t alleviate concern that investors may shun Treasuries amid the upheaval.
“It would be very disruptive to the Treasury market,” said Ward McCarthy, chief financial economist at Jefferies LLC, who’s been watching markets for 30 years. “If it comes to this, we’d expect the US to be downgraded again and it would cast a very large shadow over the US as being the gold standard of bond markets.”
S&P Global Ratings cut the US’ top rating amid the 2011 debt-limit standoff and warned last week that failure to increase the debt ceiling would likely be more damaging for the economy than the collapse of Lehman Brothers Holdings Inc.
Treasury Secretary Steven Mnuchin reiterated last week that it’s critical to raise his borrowing authority by September 29, and said he’s confident lawmakers will do so in time. The prospect of a deal may become entangled with efforts to address relief aid for Hurricane Harvey victims.
“Nobody is going to let the US government default,” Mnuchin said. House Speaker Paul Ryan told the Milwaukee Journal Sentinel that Congress has until October to act on the debt ceiling, and also said the country won’t default.
Investors have been down this road before, but a technical default would lift the showdown to another level, with ripple effects in the following areas.
Past Treasury secretaries, pushed to the limit of the extraordinary measures they can tap to stay under the debt limit, have resorted to postponing debt sales. This year, analysts say two-, five- and seven-year note sales in late September are at risk.
In 2015, then-Secretary Jacob J. Lew delayed a two-year auction. In 1996, Robert Rubin postponed sales of two- and five-year notes, as well as a one-year bill.
The Securities Industry and Financial Markets Association
and the Treasury Market Practices Group have done plenty of work to prepare for past debt-ceiling episodes.
They’re dusting off those plans now, laying the groundwork for processing debt with delayed payments. That would allow the securities to be cleared in the $1.8 trillion market for tri-party repurchase agreements.
Rates on Treasury bills due around the X-date have already risen as investors shun the debt.