Here’s how concern over the US debt ceiling could play out in markets

Investors continued to pour money into the short-term safety of the Treasury market on Friday amid concerns about the U.S. debt ceiling and the possibility of the government defaulting on its debt.

Those concerns came to the fore this week as investors looked for a safe place to hide: the 1-month Treasury bill

TMUBMUSD01M

.
Huge demand for the bill sent its yield into a steep dive on Thursday, according to TradeWeb. The rate stood at 3.348% as of 3pm ET on Friday – down 18.3 basis points from Thursday’s close of 3.531% and its lowest level since mid-October, according to Tradeweb.

According to strategists at DD Securities, volatility similar to that seen this week could soon play out as investors avoid bills maturing in July and August. That’s when TD strategists say there could be a period known as the X-date — or when the Treasury won’t be able to pay all of the U.S. government’s bills.

“Over the past week or so, 1-month bills have really started to warm up as investors try to avoid debt-ceiling issues and uncertainty about stocks and interest rates,” said Gennady Goldberg, senior U.S. rates official. Strategist at TD. “Many investors are hiding in the more liquid 1-month bills, but paying a higher price for doing so because the rate is lower than other bills,” he said in the Treasury market.

“It’s not just money-market funds, but a lot of investors, like asset managers, who typically don’t invest in the 1-month T-bill space and have a significant amount of dry powder on hand,” Goldberg, based in New York, said by phone Friday. “The closer we get to the debt ceiling X-date, the more extreme the displacement of bills will become: bills affected by the X-date will become cheaper as investors seek to avoid them. Right now, equity investors are paying more attention to earnings and economic background, but can start to get nervous when they approach the X-date without a solution.

According to: Fears of a default spur buying frenzy in 1-month Treasuries

On Friday, Treasury yields — excluding the 1-month T-bill rate — ended higher in New York trade as investors sold off most government debt and piled into short-term securities. Meanwhile, the three major US stock indexes

DJIA

SPX

COMP

It made modest gains on the day, but was marginally lower this week after the first batch of earnings reports disappointed investors.

Amid concerns this week over the T-Bill, federal tax receipts came in weaker than expected, raising concerns that the government could run out of money within months if Congress doesn’t raise the $31.4 trillion debt ceiling. That was reached in January, prompting the Treasury to take extraordinary measures. On Friday, the cost of insuring US sovereign debt is said to be high to the highest level since 2011.

On Wednesday, House Republicans unveiled a plan to cut government spending in exchange for a higher limit on government debt. In contrast, the White House and congressional Democrats have called for raising the cap without conditions.

With debt ceiling negotiations likely to be the most contentious since 2011, TD strategists said the use of the Federal Reserve’s overnight reverse repo (or RRP) facility is likely to grow in the future. The facility is mostly used by money market funds, and its use increased as a result of the Treasury’s decision to reduce the supply of bills in March and pressure on the regional banking sector. The facility’s reserves rose to $2.3 trillion.

Money that could go into T-bills maturing more than a month could be flushed out of the system very quickly, resulting in a balance-deficit episode like the one seen in September 2019, Goldberg said. He said that “going too close to the debt ceiling without a resolution could create ripples in the financial system.”