Insights from Catalyst

By John Kirby, Investment Officer

The U.S. debt ceiling situation has dominated news headlines the last few weeks, but the Treasury has been robbing Peter to pay Paul since January to meet its obligations. With time quickly running out, what are the possible implications for credit unions?

Treasury Secretary Janet Yellen has posited a June 1 ‘X-date’ when the U.S. will no longer be able to make all its outstanding payments. If the U.S. can maintain payments until June 15, a large influx of anticipated corporate tax payments could postpone the X-date for a short period.

Hyperbole aside, there are four potential effects on credit unions if the X-date is reached without a resolution:

1. The U.S. will not miss interest or principal payments on its debt obligations. Nor will it miss any payments related to entitlement benefits, including, but not limited to, Social Security and Medicare.

The Treasury Department is expected to cut spending by as much as 25% to ensure timely payments of principal and interest on its outstanding debt obligation. The only reason credit unions would not receive payments on their holdings would be if the current gridlock continues well past the X-date. No one knows how long, but similar to a bankruptcy, bond holders will be first in line for payouts.

Deposit levels at credit unions could be affected if the U.S. temporarily halts entitlement benefit payments, but all the hardware and infrastructure to remit millions of payments every month is not equipped to stop entirely, or even pause.

The Treasury will be expected to move mountains to ensure payments are made promptly. The first cuts will likely be to temporary workers, followed by full-time employee furloughs or layoffs. It is possible payments could be late, but they will be expected to be paid either way.

2. The credit rating of the U.S. would fall, affecting interest rates in nearly all sectors.

The credit rating for the United States would be downgraded for the second time in history. This may occur even if a deal is reached, because it went close to the wire, as it did in 2011, when S&P cut the U.S. to a double-A rating four days after an agreement was made.

The risk premium for U.S. Treasuries would likely rise by at least 80 basis points, depending on the term. Spreads on investment grade bonds would be expected to jump by 220 bps or more, which is higher than what was observed during the 2011 standoff.

This would implicitly lead to higher lending and borrowing rates for credit unions, not to mention an increase in rates on any asset tied to U.S. Treasuries. Management teams would need to move quickly to keep up.

3. The value of the U.S. dollar would fall.

This point seems to be overlooked by pundits, but if the full faith and credit of the U.S. comes into question, it seems inherent the U.S. dollar would lose value relative to other currencies. Just as the 10-year Treasury serves as a global benchmark for asset yields, the U.S. dollar is the world’s reserve currency, and would likely suffer a setback in pricing as a result.

4. Macro-level credit conditions will get much tighter.

The net effect of points 2 and 3 will be higher prices and likely stickier inflation than we’ve seen so far in 2023. Higher interest rates lead to higher prices as producers pass increased costs along to consumers. The corollary is that the FOMC may be forced to continue raising short-term rates to combat stagnant inflation.

Considering the unprecedented nature of the circumstances, there are a lot of questions about what the results will be if or when the U.S. defaults. However, the most likely outcome would be higher rates for everyone, and that’s after 1-1/2 years of unprecedented rate increases. Credit conditions will likely tighten to the point where a recession will be unavoidable. A plethora of other potential outcomes exist, but credit unions would be quickly affected in these ways.

Catalyst Corporate offers a wealth of knowledge, experience and solutions to help your credit union effectively manage varying economic environments, including liquidity challenges. To find out how we can help you this month and onward, book a strategy consultation today.