Every day that passes puts the United States closer to the "X Date" — the moment (estimated to be this summer) when the Treasury runs out of extraordinary measures it is using to avoid breaching the $34.1 trillion legal debt limit.
Why it matters: There are more and more signs that the possibility of protracted negotiations is causing some worry in the halls of the Fed.
Driving the news: At the Fed's Feb. 1 policy meeting, "a number of participants stressed that a drawn-out period of negotiations to raise the federal debt limit could pose significant risks to the financial system and the broader economy," minutes released Wednesday noted.
The big picture: In recent years, even when the country has come close to the brink as negotiations dragged on, critical markets underpinning the economy were jolted, according to new research from the Kansas City Fed.
Details: Researchers examined how financial conditions responded during the last three episodes of brinkmanship — in 2011, 2013 and 2021 — when the nation approached the drop-dead point at which it would no longer be able to pay its bills.
- Short-term funding costs spiked sharply as each "X Date" drew nearer. In 2021, rates were volatile as a temporary deal reached by lawmakers was set to expire.
- In the two weeks leading up to 2013's "X Date," investors yanked "unusually large" amounts from money market funds, particularly those holding government debt.
- Like now, the Treasury Department used creative maneuvers to manage its cash flow after breaching the debt limit in previous years. In each episode, the total supply of government bills fell after the Treasury implemented these measures.
What they're saying: "Although financial market risks rise when debt ceiling resolutions occur closer to x-dates, resolutions that occur after x-dates likely have the steepest consequences," Kansas City Fed economists Stefan Jacewitz, W. Blake Marsh and Nicholas Sly wrote.
- That's because, in an extreme scenario, it could risk a repeat of what happened at the pandemic's onset. There was so little demand to trade government debt that the Fed had to step in to backstop the market.
The bottom line: There's no guarantee markets will respond similarly to any drawn-out debt limit standoff as it has in years past. But there are some developments that might make this time less or more risky for investors.
- This time around, the Fed — unlike in past episodes — is in an aggressive tightening cycle and yanking liquidity from financial markets.
