The X Date is live. We now have an idea of the date on which the United States will run out of money unless the debt ceiling is raised or suspended. Treasury Secretary Bessent informed Congress last week that it would be in August, thus teeing up a made up “crisis” that occurs periodically, grabs headlines, then is” resolved” until next time.

Public funds investors have begun to see the effects of the developing “crisis” in what have been, to date, small dislocations in the short-term markets as the yields on Treasury bills maturing in August have moved higher.

The X Date drama has occurred periodically in recent years because of a law that prohibits the Federal government from incurring new debt without specific Congressional authorization. Never mind that the debt to be issued would be to pay for spending already authorized by Congress. Or if some approval is needed separately from an appropriation, why it is not done at the time funds are appropriated. Or why, once the spending is approved, a follow-on approval of borrowing would be anything other than a routine housekeeping measure.

But this is Washington at work.

As the X Date approaches, the markets—particularly the money markets—will see a rise in volatility and loss of market liquidity.  Some large buyers will avoid Treasury bills that mature in August, driving up their yields.  

This has already begin, as the accompanying chart illustrates.  Also, liquidity in these bills has begun to weaken a bit, indicated by slightly higher bid/offer spreads. If we get closer to August without resolution investors will focus on a window smaller than the current one-month period, price dislocations will expand and liquidity will diminish for very specific maturities.

These developments might be seen as an opportunity to buy cheaper Treasury bills, but they disrupt the normal trading pattern for short-maturity Treasuries and, with it, the relative prices of other money market securities like commercial paper and negotiable CDs. If we get close to the X Date with no resolution the general collateral repurchase agreement market could also be thrown into turmoil because bills that mature around the X Date could be delivered to fulfill repurchase agreement obligations. That would not suit counterparties who want to avoid exposure to these bills.

Needless to say, these developments might please speculative buyers, but they are not good for the markets.

The current debt ceiling is $36.1 trillion. It was reached in mid-2023 but then suspended until January 1, 2025, by the Fiscal Responsibility Act(!) of 2023. Since then, the government has paid its bills by employing some fancy footwork to free up cash without increasing the amount of debt outstanding. But at some point—Treasury now says the point will be in August—it will run out of fiscal magic and cash. (In May 2023, the Treasury’s cash balance dropped to about $50 billion, which is less than two business days of working capital.)

The Treasury’s cash balance is currently around $600 billion. It will benefit from the receipt of quarterly tax payments due June 15 but then decline rapidly. Spending averages about $30 billion a day, but it is not evenly distributed over a month because of large payments like Social Security and there is also uneven timing of tax receipts around quarterly payment dates. So, in coming days without Congress acting, dire warnings will take command of the financial news,  talking heads will opine on market effects and creative minds will speculate on work-arounds (“use the gold in Fort Knox” or “mint a $1 trillion coin and sell it to the Federal Reserve to raise cash.”)

Meanwhile, with August now highlighted as the X Date, the debt ceiling game is on.  The game involves “guessing” the exact date when the government would run out of money and selling bills that mature close to/after that date.

This week the yield of Treasury bills maturing in the August time frame cheapened by several basis points, reflecting the Treasury Secretary’s announcement. 

The kink in the Treasury bill curve reflects the reluctance of some buyers, particularly government money market funds, to own particular bills. These funds owned $2.8 trillion Treasuries at the end of March. Normally they would hold 30%-35% of the outstanding amounts of short-maturity Treasury bills. But money market fund managers are acutely aware of the high degree of transparency around their holdings and worry about perceptions. In the past they have avoided bills that mature around the X Date.

LGIP managers may share this perspective, though many LGIPs do not provide the same level of transparency as money market funds.

For some investors, the cheapening of these bills presents an opportunity to obtain added yield of five to 10 basis points. Proprietary trading shops and hedge fund managers who can leverage their holdings by borrowing against them, may view this as (nearly) free money.

It seems highly improbable, to say the least, that Uncle Sam will default on its debt in three months. The debt ceiling is addressed in the tax change reconciliation bill that is before the House of Representatives this week. The final reconciliation package is likely to contain language to raise the ceiling by $4 or $5 trillion. That would kick the can down the road until after the 2026 Congressional elections. Then we’ll get to see this movie again.