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3 things to know about markets and debt-ceiling fight as Memorial Day weekend nears

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Financial markets are bracing for U.S. debt-ceiling talks to come down to the wire, putting the U.S. government dangerously close to a default, as the long Memorial Day weekend approaches.

Stocks closed lower Wednesday, with the Dow Jones Industrial Average
DJIA,
-0.77%

posting a fourth straight session of declines, leaving the blue-chip index down 1.1% on the year, according to FactSet. The S&P 500 index
SPX,
-0.73%

has been stuck in a range below 4,200 for weeks.

After the bell, Fitch Ratings placed the U.S. Triple-A credit ratings on “ratings watch negative,” pointing to “brinkmanship” over the debt ceiling.

The brunt of the selloff has been in Treasury bills, especially those maturing around June 1, or the “X-date,” when Treasury Secretary Janet Yellen expects the U.S. to no longer have enough funds to pay all its bills. Those securities were at yields north of 7%, or roughly what higher-quality junk bonds fetch.

“Which is insane,” said Judith Raneri, a senior portfolio manager at the Gabelli U.S. Treasury Money Market Fund. “I’m in the camp that truly feels they are going to reach a decision,” she said of the debt-ceiling standoff. “Each party is going to have to give a little. Then we can move on.”

But before then, here are three things to know about markets and the debt-ceiling as the Memorial Day weekend draws closer:

1. Drop-dead date

House Speaker Kevin McCarthy on Wednesday said a divided Washington would still come to an agreement, adding that he “wouldn’t scare the markets in any shape or form.”

He also said that lawmakers who might like to travel ahead of the Memorial Day weekend will need to be prepared to return to Washington to vote on the debt limit.

In a sign that investors don’t expect a tidy resolution to the current $31.4 billion debt-limit soon, yields on 1-month Treasury bills
TMUBMUSD01M,
5.631%

were near 5.71% Wednesday, up from around 0.50% a year ago, according to FactSet.

“Until they come to an agreement, and we have some clarity, it’s not only in Treasurys and equities, but every other sector of the economy that is going to be impacted,” Raneri said.

In 2011, it took two days after a debt-ceiling deal reached over the weekend became law. But to avoid a potential June 1 default, the drop-dead date for a new agreement was pegged as Sunday, May 28.

While a full-blown U.S. government default could spark mayhem in global financial markets, MarketWatch’s Andrew Keshner writes that even a brief default could tip an already fragile economy into a mild recession.

Read: What happens if the debt ceiling isn’t raised? ‘If there was ever a time for a rainy-day fund, this is it.’

2. Lessons from 1979 payment blip

There may be a precedent for how the Treasury might handle missed interest payments of maturing Treasury bills caught in the eye of a debt-ceiling breach, according to the Wells Fargo Investment Institute.

A technical glitch in 1979 caused a “blip” in payment processing that caused some delays in interest payments on some Treasury bills. Legal battles and new legislation followed, providing a potential pathway to making investors whole for any delayed payments in June, strategist said in a client note Wednesday.

Raneri at Gabelli Funds said she’s been limiting exposure to Treasury bills with a maturity around the X-date, while favoring two-month and three-month bill auctions. “I think a lot of money-market funds are avoiding the short end of the curve because of this concern.”

Also read: How will the Fed react to the debt ceiling breach? Here are some plays in the playbook.

3. U.S. still has low interest payments

The U.S. hit its current borrowing limit in January, and has been running down its cash account, with Fitch Ratings pegging its balance at around $70 billion as of Wednesday.

While a new debt limit would mean borrowing from the public at much higher rates than in the past few years, Oxford Economic pegged federal interest payments as a share of gross domestic product at 1.9% in 2022, lower than the 3% in the early 1990s, “even though the level of debt is significantly higher.”

The Treasury is expected to release a deluge of Treasury bill issuance once a deal on the borrowing limit is reached. Strategists expect that rates would need to exceed the roughly 5% rate offered by the Federal Reserve’s popular reverse repo facility to entice funds marked there overnight into shorter-term Treasury debt.

Read: A debt-ceiling deal will spark a new worry: Who will buy the deluge of Treasury bills?

Ryan Sweet, chief U.S. economist at Oxford Economics, said “higher rates this year will increase interest payments as a share of GDP, but that share won’t approach the tipping point where the government is unable to finance its debt, and higher interest payments aren’t a reason to not raise the debt ceiling,” in a Wednesday client note.

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