US: Debt limit drama to have a limited near-term market impact – Danske Bank

The US debt limit suspension expires on 1 August. Analysts at Danske Bank estimate the extraordinary measures are likely exhausted in October or November, where they expect a re-suspension. They expect limited near-term market impact, but they warn a re-suspension of the debt limit could come in conjunction with the Federal Reserve starting to taper QE and result in tighter USD liquidity conditions during the fourth quarter, which is not fully priced in the market in their view.

Key Quotes: 

“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.”

“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.”

“The debt ceiling issue in the US has become a repeated game; hence, the market is well aware of the dynamics, e.g. the fall and rise in the cash balance and a deal to suspend the ceiling will come eventually. I.e. we do not expect it to be major market mover. That said the timing of the debt ceiling issue in conjunction with the path forward in Fed’s bond purchases is worth keeping in mind.”

“We look for Fed to announce and initiate tapering of its bond purchases around the November and December meeting. Hence, there could potentially be two events, which speaks of tighter USD liquidity conditions in Q4 – a solution to the debt ceiling and subsequent rise in the cash balance and tapering of bond purchases.”

“The Fed Funds futures curve is slightly inverted in the front out to around the November and December meeting. We interpret this as an expectation in the market of benign USD liquidity conditions until Q4 before they will start to turn less favourable. It fits well with our outlook for both the debt ceiling and tapering.”