The government’s cash account at the Fed, called the Treasury General Account, currently stands at $60 billion. This means a flood of newly-issued bonds will hit the markets in the following weeks, which investors need to absorb. Once a deal is found, the Treasury would need to sharply boost its borrowing, in order to replenish its cash levels and be able to honor the spending obligations of the US government. Even so, the real question is what will happen in the aftermath of the resolution. In reality, there are some extraordinary measures the Treasury can take to avert default for a few more weeks, so the real X-date might be closer to late June. Some compromise will eventually be found, hopefully before the X-date that Treasury Secretary Yellen has warned is around early June. Republicans want the government to slash spending, whereas the Democrats are only prepared to freeze public spending at current levels. This showdown is a political game of chicken, and investors are fully aware. Nobody really wants the US government to default as that would severely damage the nation’s credibility, raise borrowing costs and make matters worse for both parties.
It’s almost certain that US lawmakers will ultimately reach a debt ceiling deal, even if it takes some time. That’s when the Treasury will scramble to raise its cash levels, which can drain liquidity out of the financial system and in the process, inflict damage on riskier assets such as stocks. However, the real problem for markets might be what happens after an agreement is found. With US lawmakers unable to reach a deal on the debt ceiling, investors are laser-focused on the risk of a catastrophic default.
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