How does the debt limit affect Treasury markets and Treasury's borrowing costs?
Failure to increase (or suspend) the debt limit in a timely manner can have serious negative consequences for the market for Treasury securities and increase borrowing costs. The Treasury generally has low borrowing costs because investors are willing to pay more for the liquidity and safety offered by Treasury securities.Treasury securities are debt instruments issued by the U.S. Department of the Treasury to raise the money needed to operate the federal government.
In contrast, disruptions in the market for Treasury securities caused by uncertainty around whether the debt limit would be raised led to increases in borrowing costs in both 2011 and 2013. For those Treasury securities issued during the 2013 debt limit impasse, we estimated that the additional borrowing costs incurred through fiscal year 2014 were between $38 million and $70 million depending on the specifications used in our model.
During the 2013 impasse, investors also reported taking the unprecedented action of systematically avoiding certain Treasury securities—i.e., those that would mature around the dates when Treasury projected it would exhaust the extraordinary actions it used to manage debt as it approached the debt limit. For these securities, the actions resulted in both a dramatic increase in interest rates and a decline in liquidity in the secondary market where securities are traded among investors. In 2013, secondary market yields on Treasury bills maturing in late October through mid-November rose from about 1 basis pointA basis point is one one-hundredth of a percent (0.01%). in mid-September to over 50 basis points prior to the resolution of the impasse on October 17. Treasury securities are viewed as one of the safest assets in the world, but the significant increases in interest rates on these Treasury securities during the 2013 impasse reflected a new level of investor uncertainty about Treasury’s ability to pay its bills and avoid a delayed payment or a default.
Secondary Market Yields on Treasury Bills Maturing in Late October through Mid-November 2013
Note: The Department of the Treasury refers to actions used to manage federal debt when it is at the debt limit as extraordinary measures. For example, Treasury can suspend investments to certain federal employee retirement funds.
Disruptions to the Treasury market from the 2013 debt limit impasse also extended into other markets, such as short-term financing.