Debt Ceiling Update: X Marks the Spot

X Date: Base Case Still Early August

In mid-January, we published a report on the outlook for the U.S. federal government's borrowing limit, also known as the debt ceiling. Since then, the U.S. economy has evolved tumultuously. Employment has continued to grow at a robust rate despite challenges in certain sectors, inflation has remained uncomfortably high and two high-profile bank failures have caused turbulence in the financial system. However, one thing that has not changed over the past few months is policymakers inability to come to an agreement to increase or suspend the debt ceiling. Our sense is that Congress and the president are no closer to a debt ceiling resolution than they were when we published our last report on January 19. House Republicans may pass their own debt ceiling bill this week, but the plan contains numerous policy changes that Democratic leaders consider nonstarters, such as repealing various clean energy tax credits, blocking student loan forgiveness and steep cuts to discretionary spending over the next decade.¹

Our sense is that Congress and the president are no closer to a debt ceiling resolution than they were when we published our last report on January 19.

In the meantime, the U.S. Treasury has leaned on incoming tax revenues, cash on hand and "extraordinary measures" to remain current on all its obligations despite the binding borrowing limit (Figure 1). However, these sources of funds are slowly running dry. As of March 31, the U.S. Treasury had just $39 billion of extraordinary measure wiggle room at its disposal. Another one-time extraordinary measure that frees up approximately $133 billion of headroom under the debt limit becomes available on June 30, but for now that tool remains unavailable.² Until then, Treasury must rely on the tax receipts its receives to meet all of its obligations. Fortunately, the month of April is typically the largest month of the year for federal tax collections because of the annual filing deadline for individual income taxes (Figure 2).

Tax revenues in 2022 were unusually strong, and some payback this year was inevitable. However, April tax collections thus far have been slightly weaker than we anticipated. Non-withheld individual income taxes paid to the Treasury are running closer to 2019 levels than 2022 levels (Figure 3). This boost in tax receipts has pushed the U.S. Treasury's cash balance (also known as the Treasury General Account, which is held at the Federal Reserve) up to $280 billion from its recent low (Figure 4). This cash build-up should permit Treasury to remain solvent for a little while longer. But because the federal government runs an annual budget deficit, sooner or later additional borrowing will be needed. Thus, the “X date”, or the date on which the Treasury would be unable to meet all of its obligations on time, lies at some point in the near future. But when?

April tax collections thus far have been slightly weaker than we anticipated.

In mid-January, we wrote that early- to mid-August was our preliminary modal forecast for where the X date would ultimately land if negotiations go down to the wire. In our view, an X date in early August is still the most probable outcome. More specifically, the first three days of August seem most likely to contain the X date. Monthly Medicare Advantage and Part D payments are due on August 1, as is a large share of pay for active-duty members of the military, civil service and military retirees, veterans and recipients of Supplementary Security Income. Combined, these expenditures total roughly $65 billion and make August 1 a prime day of concern. Two days later on August 3 about $25 billion of Social Security benefits will be disbursed (Figure 5).

In our view, an X date in early August is still the most probable outcome.

However, there is a small tail risk that the Treasury could hit the X date in the first half of June. As we discussed in our preview piece, it is important to keep in mind that revenues and outlays are not evenly distributed across months or even within months. If Treasury can stretch its funds through to June 15, a quarterly deadline for corporate tax payments should bring another revenue infusion of $75 billion or so. That should be enough money to remain solvent for at least another couple of weeks, at which point the aforementioned $133 billion one-time extraordinary measure becomes available on June 30. Our federal budget deficit forecast for July happens to be in the ballpark of $130 billion, and from there it becomes more clear how our base case X date forecast lands in early August. The federal government generally runs one of its largest monthly budget deficits of the year in August, so getting to the next corporate tax payment deadline on September 15 is quite unlikely in our view (Figure 6).

There is a small tail risk that the Treasury could hit the X date in the first half of June.

However, the above analysis is contingent on getting to June 15, and the math is tight enough that Treasury could be cutting it pretty close on the eve of the quarterly corporate tax payments. In our view, this presents a difficult risk management question of how high the probability of default in early June needs to be such that Treasury weighs in with guidance that the debt ceiling must be resolved in the next six weeks. A low but not insignificant probability of a U.S. default is still very concerning and might warrant a warning from Treasury Secretary Yellen or other top Treasury officials. We would think the last thing Treasury officials want is an X date that sneaks up on Congress somewhat unexpectedly. Yields on Treasury bills appear to reflect this uncertainty. The four-week T-bill yield auctioned on April 20, which matures before June, came in at a remarkably low 3.25%. In contrast, the eight-week T-bill auctioned on the same day registered a much higher yield of 4.97%. Thus far, equity markets have been relatively calm as the debt ceiling X date barrels closer (Figure 7), and credit spreads on corporate bonds also have remained relatively in check. If Treasury gives explicit X date guidance in the coming weeks, we would expect markets to gravitate towards this as the "official" X date.

Ultimately, our economic forecast is predicated on the assumption that the debt ceiling is eventually increased or suspended with little to no collateral damage on the real economy. However, past brushes with default have tightened financial conditions, occasionally in a significant way, such as the summer of 2011. We covered whether Treasury could adopt a prioritization plan in our January report, and we would direct interested readers to that piece for further reading. But as a reminder, even if a payment prioritization plan is implemented by the Treasury Department, such a plan would be entirely experimental and would still come with a litany of legal, technical, economic and political challenges. The economic impact of a default is highly uncertain since that has never happened previously, but economic modeling suggests the fallout could be quite severe.³ For now, we will continue to monitor developments closely, and we will keep our readers updated on our latest thinking. Stay tuned.

Our economic forecast is predicated on the assumption that the debt ceiling is eventually increased or suspended with little to no collateral damage on the real economy.

Endnotes

¹For more information on the House Republican plan, please see this article. (Return)

²As of March 31, the federal retirement thrift savings fund had $22.3B of nonmarketable Treasury securities and the Exchange Stabilization Fund had $16.6B. For further reading on these sources of extraordinary measures, please see this memo from the U.S. Treasury. (Return)

³ Engen, Eric; Follette, Glenn; Laforte, Jean-Philippe. "Possible Macroeconomic Effects of a Temporary Federal Debt Default" Federal Reserve Board. October 4, 2013 (Return)