One corner of the Treasury market is worried the U.S. government could default this fall, even though many strategists believe Congress will raise the debt ceiling just in time.
The Treasury bill that comes due in October has been selling off, and is currently yielding more than the bills that mature in September and November, amid concerns the government would hit the debt limit at the beginning of October and not have funds to pay investors.
While Congress is expected to act to raise the debt ceiling — the legislative cap on how much the government can borrow — it isn't expected to forego its usual drama.
"I think we will ultimately see a resolution, but it would not surprise me to see this go down to the middle of September, end of September to get this done. They [bills] could cheapen more," said Mark Cabana, head of U.S. short rate strategy at Bank of America Merrill Lynch.
The Treasury bill due Oct. 12 was yielding 1.08 percent Tuesday, while the Nov. 9 bill was yielding less – 1.03 percent. The September, 1-month bill, was yielding 0.99 percent. The normal progression is that the later-dated bills would yield more. Analysts say the November bill is yielding less than the October bill because the market believes any issue would be quickly resolved.
"We now have Congress in recess. They're not expected to come back until Sept. 5. At that point, there's only 12 days when the House and Senate are jointly in session," Cabana said. "The market is right to price in some potential that things could go wrong, but our baseline is it will not get to that point and we will see some resolution."
Congress suspended the debt ceiling in November 2015 for 17 months, ending in March. Since then the Treasury took extraordinary measures to fund the budget deficit, but it is expected to run out of capacity by early October. Treasury Secretary Steven Mnuchin has warned Congress it has to raise the ceiling by Sept. 29.
Stocks, meanwhile, have shrugged off any concerns so far, t if Congress does not show signs of moving forward ont the debt ceiling. Both the Dow and new highs during Tuesday trading.
"There's a slight risk it could become a broader market issue if there's concern that there's dysfunction on a core issue like this," said Tom Block, Fundstrat Washington policy strategists.
Congress also has a budget vote ahead in September. Block said Sept. 30 is the last day of the current fiscal year, setting up midnight on that day as a new "fiscal cliff," which could result in a government shutdown if Congress doesn't vote on funding.
"Half the fiscal cliff is the need to increase the debt ceiling; the other piece is the threat of a government shutdown if Congress does not pass spending bills for the 15 Departments of the government. 2013 was the last government shutdown as the Republican Congress tried to pressure President Obama, it was generally viewed as a big loss for the Republicans," noted Block.
HSBC chief U.S. economist Kevin Logan points out that the conservative wing of the House, the "Freedom Caucus," has said they want debt limit increases combined with curbs on spending.
"Republican Congressional leaders have issued assurances that, despite these potential conflicts, the debt ceiling will be raised in a timely fashion. However, they have not indicated how it will be done," wrote Logan in a note. He said normally Congress attaches the debt ceiling to some legislation that would be voted on favorably.
Block said President Donald Trump could become key in pushing for the debt ceiling raise with members of his own party, especially since some may be facing primary challenges ahead of the 2018 election.
"This is an issue where Donald Trump could really play a very positive role. The political problem with increasing the debt ceiling is Republicans are concerned about someone running in the primary to their right. This is the problem both [Senate Majority Leader Mitch] McConnell and Speaker [Paul] Ryan have in coaxing some people to vote for it," Block said. "I think Trump has the potential to inoculate Republicans who support him on the debt ceiling."
Block said he expects Washington to come together and pass the debt ceiling and budget resolution. "You assume so, but I think as Trump could help a lot, Trump could also hurt a lot if he doesn't listen carefully and say the right thing…and he has said the wrong things on this issue," he said. "If Trump repeats that we could use a good government shut down, that would not be a positive thing as the day approaches."
Strategists also said the Republican leadership could reach across the aisle and seek Democratic help if conservatives won't vote to lift the debt ceiling. Logan said the debt ceiling could also be suspended again.
Block said the last time the ceiling was breached was in 1979, and it ended up with government paying higher interest rates.