DEBT CEILING UPDATE: WILL SANTA’S SACK BE FILLED WITH COAL?

Takeaway: We are likely to hit the Debt ceiling right around Christmas day; that may be used politically to hamper or delay Fiscal Cliff negations.

SUMMARY BULLETS:

  • Our analysis suggests we are likely to hit the Debt ceiling right around Christmas day. More specifically, the US Treasury is on pace to breach the Debt Ceiling on 12/24 in Scenario A (the average pace of daily net debt issuance for business days during FY13) and on 12/26 in Scenario B (the average pace of daily net debt issuance for business days during FY11-FY13).
  • It may be that the Treasury dramatically slows or stops issuing new debt altogether around Christmas time, but the point remains: the US government is likely to breach its Congressionally-imposed $16.394 TRILLION Debt Ceiling right around then. Notably, this late-DEC estimate is a bit shy of our previous projection of JAN ’13.
  • The paramount implication of a late-DEC Debt Ceiling breach is that it would likely give the GOP – particularly House Republicans – bargaining leverage in any fiscal cliff negotiations. To some extent, one could’ve argued that the public handed the leadership conch to the Democrats based on the recent election results, but a renewed Debt Ceiling impasse could actually strengthen the Party’s resolve in any Fiscal Cliff negotiations.
  • On the margin, that would be negative for US GROWTH over the intermediate term to the extent any cliff resolution is delayed and/or thwarted outright.

While much Manic Media attention has been given to Fiscal Cliff negotiations in recent weeks (and rightfully so), we on the Hedgeye Macro Team continue to warn clients that the timing of the Debt Ceiling breach dramatically lowers the probability of a “grand compromise” that we think the throng of investors that remain bullish on the equity market is likely hoping for.

As an aside, per the latest BofA/ML fund manager survey, hedge fund net exposure to equities at 40% is the highest since JUN ’07 – coincidentally right around the last time we saw the corporate earnings cycle roll over like we are seeing today (refer to our Q4 Macro Theme of #EarningsSlowing for more details).

Per everyone’s favorite Treasury Secretary Tim “The ‘Tools’ Man” Geithner, “the government could bump into its borrowing limit before the end of the year”, though he was quick to remind the audience that “the Treasury has enough tools to keep the government afloat into early 2013”.

We’ll take his word on the latter part of his statement, as we learned from MAY 16, 2011 to AUG 2, 2011 (~2.5 months) that the Treasury Secretary does indeed have a robust bag of tricks to help the government stave off a technical default. As a reminder, those tools include (but are not limited to):

  • Declaring a “debt issuance suspension period”;
  • Suspending (until further notice) the issuance of State and Local Government Securities;
  • Prematurely redeeming existing Treasury securities held by the Civil Service Retirement and Disability Fund;
  • Suspending new issuance of Treasury securities to that fund as investments;
  • Suspending the daily reinvestment of Treasury securities held by the Government Securities Investment Fund of the Federal Employees Retirement System Thrift Savings Plan; and
  • Suspending the daily reinvestment of Treasury securities held as investments by the Exchange Stabilization Fund.

It’s worth noting that each of these steps is overwhelmingly benign as it relates to any implications for the economy and/or financial markets. To the extent you’re interested, however, or would like to brush up on historical Debt Ceiling impasses for any clues as to how this one may play out (1985, 1995-96, and 2002-03), please review our MAY 11, 2011 note titled: “FEAR MONGERING MEETS BRINKSMANSHIP: A COMPREHENSIVE GUIDE TO NAVIGATING THE DEBT CEILING DEBATE”. The conclusion of that note was as follows:

“We expect the current debt ceiling debate to heat up substantially in the coming weeks, resulting in a measured pickup in volatility across global financial markets, primarily as a result of increased  volatility in the US Dollar being driven by the whims of D.C. politicking. Further, we expect the debt limit to be increased prior to any sort of default on any of the federal government’s obligations. And within that legislation, we would expect to see the groundwork laid for potentially meaningful fiscal reform ahead of the FY12 budget debate – an event that is likely to prove dollar bullish when it’s all said and done.”

With the looming Fiscal Cliff (inked back in late JUL ’11; ~$8 TRILLION in tax hikes and spending cuts over the long term) posing as “the groundwork laid for potentially meaningful fiscal reform” and the US Dollar Index up about +8% since publication (in spite of now-perpetual QE and Bernanke perpetually kicking the can down the road on interest rate hikes), that call has proved to be rather prescient.

Jumping ahead to the current Debt Ceiling showdown, we do not take Geithner’s words on the timing of the upcoming breach at face value. Rather, we conducted our own analysis that suggests we are likely to hit the Debt ceiling right around Christmas day. More specifically, the US Treasury is on pace to breach the Debt Ceiling on 12/24 in Scenario A (the average pace of daily net debt issuance for business days during FY13) and on 12/26 in Scenario B (the average pace of daily net debt issuance for business days during FY11-FY13).

DEBT CEILING UPDATE: WILL SANTA’S SACK BE FILLED WITH COAL? - 1

 

DEBT CEILING UPDATE: WILL SANTA’S SACK BE FILLED WITH COAL? - 3

It may be that the Treasury dramatically slows or stops issuing new debt altogether around Christmas time, but the point remains: the US government is likely to breach its Congressionally-imposed $16.394 TRILLION Debt Ceiling right around then. Notably, this late-DEC estimate is a bit shy of our previous projection of JAN ’13.

The paramount implication of a late-DEC Debt Ceiling breach is that it would likely give the GOP – particularly House Republicans – bargaining leverage in any fiscal cliff negotiations. To some extent, one could’ve argued that the public handed the leadership conch to the Democrats based on the recent election results, but a renewed Debt Ceiling impasse could actually strengthen the Party’s resolve in any Fiscal Cliff negotiations. On the margin, that would be negative for US GROWTH over the intermediate term to the extent any cliff resolution is delayed and/or thwarted outright.

Per House Minority Leader Eric Cantor this week:

“Resolving the issues surrounding the fiscal cliff, especially the replacement of the sequester, and the next debt limit increase will require that the president get serious about real entitlement reform.”

Moreover, House Speaker John Boehner was out earlier in the week saying he would not allow Congress to duck tough decisions with another round of short-term measures. To the extent he holds the GOP true to his words, we could be looking at one messy political showdown in the coming weeks – especially if the Republican Party continues balk at any revenue increases outside of “dynamic scoring” (i.e. closing loopholes and reducing deductions).   

As if Washington D.C. wasn’t messy enough…

Darius Dale

Senior Analyst