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The US debt limit suspension expires on 1 August. The extraordinary measures are likely exhausted in October or November, where we expect a re-suspension.
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US Treasury expects a cash balance of USD450bn by the end of July and a cash balance of USD750bn by end of September in case the debt limit is re-suspended.
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We expect limited near-term market impact, but a re-suspension of the debt limit could come in conjunction with Fed starting to taper QE and result in tighter USD liquidity conditions in Q4, which is not fully priced in the market in our view.
The US debt limit suspension expires on 1 August. If the debt limit is not increased or resuspended, the US can no longer issue bonds (besides replacing maturing debt) and needs to rely on so-called extraordinary measures to finance deficit. The debt limit issue is not the same thing as a government shutdown, which occurs when there is no budget.
Extraordinary measures include the G Fund, the Exchange Stabilization Fund and the cash balance (among others). According to the Congressional Budget Office, the extraordinary measures are likely exhausted in October or November (although COVID-19 makes it harder to predict than usual). US Treasury Secretary warns that the extraordinary measures may be exhausted earlier.
Unlike previous rounds of debt limit problems, US Treasury does not need to draw dawn the cash buffer to the level prevailing before the debt limit was suspended (around USD118bn). Still, US Treasury is not allowed to issue a lot of bonds ahead of the expiration of the suspension and hence US Treasury expects a cash balance of USD450bn by the end of July. US Treasury expects a cash balance of USD750bn by end of September in case the debt limit is re-suspended, which is more than enough to cover 1-week outflows.
In the very near-term, a bipartisan deal seems unlikely. There are already discussions about a bipartisan deal on infrastructure but the Republican leadership is upset about the Democrats’ wish to increase spending (and taxes) further focusing on social and health care.
Senate Minority Leader Mitch McConnell (Republican) said he “cannot imagine a single Republican” voting to raise the debt limit due to the Democrats’ “free-for-all for taxes and spending”.
However, we also know that no one is interested in an US default, which is the outcome if the extraordinary measures run dry. So also this time around we expect a solution to be found eventually (although we may have to get very close to the deadline), which is probably also the reason why risk sentiment is so far unaffected by the political turmoil.
Besides a bipartisan deal on re-suspending the debt limit, the Democrats may also choose to “go alone” including a solution in a reconciliation bill, possibly in connection with one of President Biden’s spending packages. That requires that Democrats quickly find common ground on what they want to achieve on spending before the extraordinary measures.
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