Watch as Yellen makes US debt reappear

I’ve gotten a few emails about the debt ceiling and where I see it heading next, when the true x-date is, and how to best position yourself for what is coming. I’ll try to address as many of the questions I received as I can.

A month ago, I addressed who I thought had the power (McCarthy), who could bluff the longest (the dems), and who had the ability to exert the most pressure (the Fed). I have been using the US treasury yield curve as a proxy for how the market believes the battle is going.

The market has gotten increasingly anxious over the battle. You see this in the 1-month t-bill rate which is fetching an astounding 5.62%! This is the market pricing in the possibility of a delayed payment. The higher rate reflects the premium that buyers of short-term treasuries are demanding to hold those notes.

Now there has been a flurry of headlines about meetings. While the McCarthy/Biden meetings garnered the most headlines, the more important meeting was yesterday between Yellen and bank leaders including Jamie Dimon. This was a follow-up from the meeting the bank leaders had with Schumer.

There were not many details about this meeting that got out into the public. The only concrete thing I could find was a frantic message from Janet Yellen stressing the need for Congress to address the debt ceiling.

Yellen discussed the "urgent need for Congress to address the debt limit and underscored the real and severe consequences of default for the banking system and the domestic and global economy," the readout said. Yellen described how a failure to raise or suspend the debt limit would be "catastrophic" for the financial system, families and businesses — a point echoed by Dimon and other executives themselves in public comments.

It is interesting to me that Yellen would hold this meeting with Dimon. Jamie is arguably the man pulling the levers behind the curtain.

So for Yellen to go straight to the source should be a big tell in who has the power and who does not. Another tell is the increasingly desperate attempts by the democrats to raise the debt ceiling without spending cuts. There have been two separate attempts (one in the Senate and one in the House) to put forth a bill that would be a “clean” debt limit increase. That is, a debt limit increase without spending cuts. Schumer put one together right as McCarthy got the House bill passed. This week, we saw minority leader Jeffries attempt to force a “discharge petition” to get a clean raise of the ceiling. The Senate bill is a non-starter in the House and the “discharge petition” went nowhere. I’ve also seen several lawmakers urge Biden to use the 14th amendment to unilaterally raise the debt limit.

Every expert out there has said that this would not be legal. Only non-serious players are getting on board and urging this solution.

I thought the democrats would be more in control of the game here. I figured that they would care less if the “full faith and credit” of the US would be harmed by a failure to pay the debt. Not only would it cause the US to look like a poor place to park cash, it would also usher in a fierce recession. Crashing the economy now means we could be in recovery mode just in time for the 2024 elections. This seemed like a win-win for the dems. On the other hand, there’s this:

To put it plainly, Biden is getting trounced in the polls. The administration went into this debt ceiling showdown from a position of serious weakness. Now they need a win at any cost. I feel they’ll throw a fit at the amount of spending cuts the republicans are putting forth but will call it a win because the debt limit gets raised. When this happens, expect Janet Yellen to open the flood gates on treasury issuance.

This is going to have two consequences. The first is that treasury rates are going to go higher. We have a situation where a large amount of supply is going to come onto the market. Price is going to have to drop to clear the market. When bond prices go down, rates rise. Secondly, banks are going to be on the hook to pick up the tab. This is going to put a further strain on the liquidity of the banking sector. Lending conditions could easily get tighter due to heavy treasury issuance.

As far as positioning goes or how to play this in the market, I’m not here to place a short-term bet. I’m really looking for this to create a wash-out effect in the regional banking sector so that I can pick up a handful of these regional banks on the cheap. I have a feeling it is going to be another 3-9 months before we see the bottom of this regional banking cycle. So far, the signs are pointing towards increasing pain for these banks.

I expect another bank or two to go down and maybe a few more to get downgraded but have no fear, Yellen and Powell both say that the banking system is sound and resilient.