Investors are increasingly seeking the safety of the shortest-dated US Treasury market securities as concerns mount over the US debt ceiling and the possibility that the government may default on its debts. These concerns led to colossal demand for the 1-month Treasury bill, driving its yield into a steep dive. At one point on Thursday, the yield on the 1-month Treasury bill fell by over half a percentage point to 3.215% before paring the drop, according to Tradeweb. On Friday, the rate settled at 3.348% as of 3 p.m. Eastern time — down 18.3 basis points from the same time on Thursday. The US government may soon run out of money if Congress doesn’t raise the statutory borrowing limit, also known as the debt ceiling, and investors appear keen to own ultra-short-term bonds that mature just after the breach could occur.
Investors fear that Democrats lack sufficient votes in their caucus to increase the size of the $28.4 trillion debt ceiling on their own, warning that opposition by Republicans may result in debt default. Keeping the debt ceiling unchanged would not allow the government to issue new debt for new spending. Without an increase in the debt ceiling or suspension, the Treasury needs to roll over its expiring debt to avoid a credit event. Some politicians and Wall Street executives expect lawmakers to extend the nation’s borrowing limit after Treasury Secretary Janet Yellen said the government would run out of cash by October 18, barring a last-minute intervention.
In the US bond market, the yields of various bonds don’t typically jggle in parallel in response to interest-rate changes. However, as default concerns spread through the bond market, the movements of bond yields began to resemble one another more closely. Yields on one-year Treasuries also dropped significantly, falling 13 basis points on Thursday, as the Democrats struggled to work out a plan to extend the nation’s borrowing limit. The Treasury’s rates on longer-dated maturities also fell.
This shows that investors increasingly believe default could be a possibility, reflecting how the safe-haven strategy may be unraveling. The last time 1-month Treasury bills collapsed like this was during the 2008 financial crisis, when investors took their money out of risky assets and put it into bonds. To some extent, this strategy has been successful, with prices of government bonds rising as investors withdrew from risky assets. If the debt ceiling is not raised, it will be hard for the government to pay back the debt it owes, and this could affect the longer-term outlook for Treasury yields.
However, it’s worth noting that the same flight-to-safety pattern is evident when investors buy long-dated Treasury bonds. As investors moved from high-risk equities and other investment products into longer-term debt, the yields on longer-dated bonds started tumbling. This is simply a sign of how desperate the market has become to escape the effects of the indebtedness crisis.
The longer this problem goes on, the more investors will become risk-averse and seek the safety of government bonds, driven by fears of a government default. With no consensus in Congress about whether and how to resolve the US debt ceiling crisis, the potential for more extreme bond market moves is becoming more pronounced.
Overall, the investment community’s attention is now squarely on Congress and not the US Federal Reserve, as the debt ceiling debate is creating market distortions and driving investor sentiment. The debt ceiling crisis is heightening risk aversion and forcing investors to seek government bonds instead of making investments in the more volatile equity and commodity markets. This scenario is increasing the demand for Treasury securities even as government default concerns rise.
In case Congress remains at an impasse on extending the debt ceiling, the market might have to deal with more uncertainty and increased demand for Treasury bonds. Nonetheless, the longer the deadlock persists, the greater the risk of a credit event that could undermine market confidence and trigger losses for investors. Although the investment community is cautiously optimistic that a last-minute deal will be struck, the current situation highlights the fragility of the bond market and the potential risks that it poses to financial markets.