What you’re not hearing about the debt ceiling solution and long-term yields

As we predicted, it looks like a compromise has been reached to suspend the debt ceiling and avoid technical Treasury default. The deal has to get through the House and the Senate despite opposition by hard-liners, but there are sufficient moderates to carry it. The Treasury has to execute more than $900 billion of “revenge issuance” to make up for what will be almost five months on the sidelines. Based on historical precedent, we do not expect this to lead to a sharp back-up in Treasury yields as many fear. Since 2011, across multiple debt ceiling deals, the average 10-year back-up over thirty days is zero. We also do not expect any meaningful fiscal drag from purported budget cuts in the deal. They are trivial to begin with, and unlikely to be enforced – just as the budget sequesters following the 2011 debt ceiling crisis were not. Biden says he will seek a Supreme Court test of the 14th Amendment to determine that the debt ceiling is unconstitutional. If he prevails that will remove an important risk premium from markets.