Businesses, investors and markets are preparing in case debt ceiling talks fail

As Washington moves closer to reaching the federal debt ceiling, the risks of a business-as-usual approach for companies like Tipalti are increasing. If Congress doesn’t raise the government’s borrowing limit soon, the markets for stocks, bonds and currencies could go haywire, turning the government’s financial problems into a problem for business as well.

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To avoid unknown dangers, Spoja recently removed Tipaltis funds from short-dated Treasury bills maturing around the June 1 date, when the government may run out of cash. She has switched from corporate bonds to safer money market funds, even though they pay lower returns. And she’s stored enough cash in five currencies to cover two months’ salary.

For the people responsible for managing a company’s cash and making sure they have the right investment policies in place, the past six months have been really challenging, she said. The debt ceiling crisis and current uncertainty are just one more thing that CFOs have to deal with.

Spojas strategy illustrates how even the prospect of government failure is already shaping business and financial market decisions. With time running out for President Biden and House Speaker Kevin McCarthy (R-Calif.) to strike a deal, some investors try to shield themselves from a potential catastrophe and others see an opportunity to make a profit whether or not a default occurs or is prevented at the last minute.

Since the United States has never defaulted on its debts, no one knows exactly how bad the financial carnage would be if it did. But many executives with millions or billions of dollars on the line aren’t waiting to find out.

Money market fund managers eschew short-dated Treasury bills, normally one of their default investments. The absence of funds is particularly notable as they have recently experienced a strong influx of depositors fleeing the low interest rates at banks.

Hedge funds buy insurance on government debt, which would pay off big if the government misses a scheduled payment. And prominent companies like Apple, Merck and ConocoPhillips are scrambling to raise money before the debt ceiling stalemate turns routine bond market operations upside down.

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Executives from JPMorgan Chase, the nation’s largest bank, meet every day in a special war room, CEO Jamie Dimon told Bloomberg earlier this week. If no agreement is reached as the deadline approaches, they can meet up to three times a day.

There is real investor nervousness about default risk, said Priya Misra, head of global interest rate strategy for TD Securities. The private sector does a lot of hoping and praying that someone blinks.

If Congress does not raise the $31.4 trillion debt ceiling, the Treasury Department will soon be unable to pay the country’s bills. Treasury Secretary Janet L. Yellen said earlier this month that this could potentially happen as early as June 1.

On Friday, the Congressional Budget Office said there is a significant risk that the government will exhaust its spending headspace in the first half of June.

Fearing unpredictable trading next month, companies are accelerating their efforts to raise money from investors. Through Thursday, investment-grade corporate bond issuance totaled nearly $64 billion in May.

In just nine trading sessions, companies raised nearly as much as they raised in the entire month of April. Junk bond sales are also above the pace of the past month.

Merck, who declined to comment, raised $6 billion, Apple brought in $5.25 billion and Este Lauder made $2 billion. Apple and Estee Lauder did not respond to a request for comment.

The stakes of the debt ceiling fight are so monumental because of the role government bonds play in global finance. Investors view U.S. Treasury bonds, bills and bills as risk-free assets. Everything else, such as stocks, corporate bonds and debt issued by other governments, is priced relative to government bonds.

A default would expose Treasurys as riskier than investors assumed. But how much riskier would be unclear for some time, leaving investors uncertain about the price of everything they own.

That scenario is so dangerous that most financial market participants and business leaders expect politicians to compromise, as they have done in previous confrontations. The stock market has shown few signs of concern so far.

We know how this is going to end. A solution arrives just before midnight; that’s the common view, said Jack McCullough, president of the CFO Leadership Council, a trade association.

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For corporate finance executives like Spoja, the deadlock over the debt ceiling is just the latest headache. The Federal Reserve raised interest rates at its fastest pace in four decades, both slowing the economy and contributing to the bankruptcy of several regional banks.

At Tipalti, in Foster City, California, debt ceiling concerns have underlined the need to reduce risk and build liquidity. The company derives its name of a Hebrew phrase meaning I dealt with it, which is exactly what Spoja is trying to do as CFO.

About 60 percent of the company’s more than 1,000 employees work outside the United States. Payroll is divided into US and Canadian dollars, euros, British pounds and Israeli shekels.

The company’s short-term bills could run into the hundreds of millions of dollars, she said.

Spoja usually converts dollars into other currencies on the spot market when it comes time to issue pay checks. But now she has built up a two-month currency buffer that allows her to avoid the currency market while the politicians brag and negotiate.

I just don’t want to do payroll around June 1, she said.

Typically, Spoja would invest some of the company’s available cash in top-quality short-term corporate bonds, including bonds issued by various banks.

But with so much uncertainty about what the markets will look like in the next 30 days, and the banks looking so unsettled, she’s turned to money market funds instead. While those provide slightly lower returns, it’s easier to get in and out of cash funds, making Tipalti less likely to fall into a trap when markets freeze.

Jerry Klein has the other side of that box.

As head of the corporate cash management group for Treasury Partners in New York, Klein manages the short-term cash needs of clients, including venture-backed startups and Fortune 500 giants.

Their accounts range in size from approximately $50 million to $1 billion each and are invested in institutional money market funds, insured bank deposits and bond portfolios. Many customers have contacted Klein to ask if they should run for cover.

Some investors have already done so. When they dumped one-month Treasuries due in early June, the prices of those securities fell while their yields rose (bond prices and yields move in opposite directions).

One-month T-bills that mature around the date the government runs out of cash yield about 5.5 percent, about 0.3 percentage points higher than three-month bills. That may not sound like much. But it’s an unusually large positive gap for these types of instruments. On every $1 million, the higher yield would translate into an additional $3,000 in annual interest.

We actually think these bills are good value right now, Klein said. US Treasuries are still the safest investment in the world.

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Treasury Partners believes that the debt ceiling battle will be resolved before the United States fails to make a debt payment. In the worst-case scenario, the government could go into technical bankruptcy by paying a day or two late as politicians scramble to reach an agreement, he said. In that case, investors would eventually get what they owe, Klein said.

He’s not the only one who sees opportunity amid the political bickering. Investors buy insurance against a US default, known as a credit default swap, pushing the price of such protection to its highest level since the 2011 crisis.

According to S&P Global Market Intelligence, insuring $10,000 of government bonds against default for a year costs about $174, more than 10 times as much as in January.

Hedge funds buy a lottery ticket, says Mark Zandi, chief economist at Moodys Analytics. It doesn’t cost much to buy it and you get a big payout when you win.

Others warn against getting too smart. Tony Roth, chief investment officer of Wilmington Trust, which manages $100 billion in assets, sees little opportunity for investors to trade profitably around the debt ceiling.

During a previous debt run-off in 2011, the stock market fell about 15 percent before recovering. But picking the right time to reinvest is not easy, meaning investors trying to avoid a downdraft risk missing out on an eventual upturn.

We have a small chance of a bad outcome, Roth said. But we have a good chance of relief if nothing happens.

Tipaltis Spoja attended a dinner with some other CFOs on Wednesday night. They were all thinking about the same dilemma: It’s almost impossible to imagine the United States actually defaulting on a debt. But if it happens, the consequences will be disastrous.

Managing the finances of a growing business is hard enough. Charting a course through the current quagmire is a test of corporate finance professionals’ ability to assess political risk, market opportunity, and the opportunity costs associated with choosing one approach over another.

I grew up in Washington so I feel like I’ve seen this before. I always look back to DC to make sure they’re not doing the wrong thing, Spoja said. A true default would hurt anyone.