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    Wall St. Is Counting on a Debt Limit Trick That Could Entail Trouble

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    If the debt limit is breached, investors expect Treasury to put bond payments first. It’d be politically and practically fraught.Washington’s debt limit drama has Wall Street betting that the United States will employ a fallback option to ensure it can make good on payments to its lenders even if Congress doesn’t raise the nation’s borrowing limit before America runs out of cash.But that untested idea has significant flaws and has been ruled out by the Biden administration, which could make it less of a bulwark against disaster than many investors and politicians are counting on.Many on Wall Street believe that the Treasury Department, in order to avoid defaulting on U.S. debt, would “prioritize” payments on its bonds if it could no longer borrow funds to cover all its expenses. They expect that America’s lenders — the bondholders who own U.S. Treasury debt — would be first in line to receive interest and other payments, even if it meant delaying other obligations like government salaries or retirement benefits.Those assumptions are rooted in history. Records from 2011 and 2013 — the last time the U.S. tipped dangerously close to a debt limit crisis — suggested that officials at the Treasury had laid at least some groundwork to pay investors first, and that policymakers at the Federal Reserve assumed that such an approach was likely. Some Republicans in the House and Senate have painted prioritization as a fallback option that could make failure to raise the borrowing cap less of a disaster, arguing that as long as bondholders get paid, the U.S. will not experience a true default.But the Biden administration is not doing prioritization planning this time around because officials don’t think it would prevent an economic crisis and are unsure whether such a plan is even feasible. The White House has not asked Treasury to prepare for a scenario in which it pays back investors first, according to multiple officials. Janet L. Yellen, the Treasury secretary, has said such an approach would not avoid a debt “default” in the eyes of markets.“Treasury systems have all been built to pay all of our bills when they’re due and on time, and not to prioritize one form of spending over another,” Ms. Yellen told reporters this month.Perhaps more worrisome is that, even if the White House ultimately succumbed to pressure to prioritize payments, experts from both political parties who have studied the temporary fix say it might not be enough to avert a financial catastrophe.Senator Ted Cruz, center, and other Republicans during a news conference on debt ceiling on Capitol Hill last week.Haiyun Jiang/The New York Times“Prioritization is really default by another name,” said Brian Riedl, formerly chief economist to former Republican Senator Rob Portman and now an economist at the Manhattan Institute. “It’s not defaulting on the government’s debt, but it’s defaulting on its obligations.”Congress must periodically raise the nation’s debt ceiling to authorize the Treasury to borrow to cover America’s commitments. Raising the limit does not entail any new spending — it is more like paying a credit-card bill for spending the nation has already incurred — and it is often completed without incident. But Republicans have occasionally attempted to attach future spending cuts or other legislative goals to debt limit increases, plunging the United States into partisan brinkmanship.Understand the U.S. Debt CeilingCard 1 of 5What is the debt ceiling? More

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    Smaller Rate Increase by Federal Reserve Likely as Inflation Cools

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    America’s central bank is expected to raise rates by a quarter point on Wednesday. The question now is what comes next.Federal Reserve officials are widely expected to raise interest rates by a quarter point at their meeting this week, further slowing what had been an aggressive pace of rate increases in 2022 as they wait to see how swiftly inflation will fade.Moving gradually will give Fed officials more time to assess how high rates need to rise and how long they need to stay elevated to fully wrangle inflation, both of which are looming and crucial questions. The answers will help to determine how much damage the Fed inflicts on the labor market and broader economy in its quest to control price increases.Central bankers raised interest rates from near zero to above 4.25 percent last year, and they are expected to lift rates to a range of 4.5 to 4.75 percent on Wednesday. Investors will be even more attuned to what may come next, and will parse the Fed’s 2 p.m. statement and the subsequent news conference by the Fed chair Jerome H. Powell for clues about the future.Fed officials predicted in December that they would lift rates to just above 5 percent in 2023, then hold them at a high level throughout the year. But incoming data will drive how high the Fed raises rates and how long they keep them at that level.Since the Fed’s last decision, inflation has meaningfully slowed, and data on the economy show that consumers are becoming more cautious and beginning to spend less. Anecdotes suggest that shoppers may be more sensitive to prices, which would make it more difficult for companies to continue passing along big price increases. At the same time, the job market remains very strong, and economists and central bankers have warned that a re-acceleration in growth and inflation remains possible. That is likely to keep the Fed wary of prematurely declaring victory over inflation.“They’re going to stay vigilant on inflation — I don’t think they’re going to break out the ‘mission accomplished’ banner just yet,” said Gennadiy Goldberg, a rates strategist at T.D. Securities. “If they don’t send the signal that they really want to get inflation under control, the market could over-interpret that as a signal that they’re done. That’s not the message they want to send.”Wall Street will be focused on one word in particular in the Fed’s policy statement: “ongoing.” In recent months, central bankers have stated that “ongoing increases in the target range will be appropriate.”Inflation F.A.Q.Card 1 of 5What is inflation? More

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    Fed Rate Increases Have ‘A Ways to Go,’ Top Official Says

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    Christopher Waller, a Federal Reserve governor, said he favored a quarter-point move. Many of his colleagues agree — or haven’t ruled it out.Christopher Waller, a Federal Reserve governor, added his voice on Friday to a chorus of central bank officials who favor slowing rate increases at the central bank’s Feb. 1 meeting. That most likely locks in place market expectations for a return to smaller policy adjustments after a series of jumbo rate moves.Mr. Waller spoke on the eve of the central bank’s quiet period before its meeting, which means investors will not hear any more commentary from Fed officials before they make their rate decision. His comments were in line with what many of his colleagues have said: Several openly support slowing down rate increases at the meeting, and top policymakers who haven’t made up their minds have not ruled it out.Central bankers raised rates rapidly in 2022, lifting borrowing costs in three-quarter-point increments for much of the year, before slowing to a half-point move in December. But they are entering a new phase that is focused more on how high interest rates rise and less on how quickly they get there. The thinking is that rates are now high enough to meaningfully slow the economy, and that adjusting them more gradually will give policymakers time to see how their policy is working.That has nudged policymakers toward a quarter-point increase, also known as 25 basis points, an increment that was common before the pandemic.“After climbing steeply and using monetary policy to significantly raise interest rates throughout the economy, it was apparent to me that it was time to slow, but not halt, the rate of ascent,” Mr. Waller said of the December downshift. “There appears to be little turbulence ahead, so I currently favor a 25-basis-point increase” at the Fed’s next meeting, he said.Inflation F.A.Q.Card 1 of 5What is inflation? More

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    As Debt Ceiling Threat Looms, Wall Street and Washington Have Only Rough Plans

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    A default would most likely rattle markets and carry big risks, no matter how the Federal Reserve and Treasury try to curb the fallout.With days to go before the United States bumps up against a technical limit on how much debt it can issue, Wall Street analysts and political prognosticators are warning that a perennial source of partisan brinkmanship could finally tip into outright catastrophe in 2023.Big investors and bank economists are using financial models to predict when the United States, which borrows money to pay its existing bills, will run out of cash. They are assessing what it could mean if the government is unable to pay some of its bondholders and the country defaults on its debt. And they are gaming out how to both minimize risks and make the most of any opportunities to profit that might be hiding in the chaos.The need to start planning for a potential debt limit breach became more urgent last week, when Treasury Secretary Janet L. Yellen told Congress that the United States would hit its borrowing cap on Thursday. At that point, Treasury will begin using “extraordinary measures” to try to stay under the cap for as long as possible — but those options could be exhausted as soon as June.Congress places a limit on the amount of debt the country can issue, with a simple majority in the House and Senate required to lift it. That cap, currently $31.4 trillion, needs to be adjusted to allow the United States to borrow to pay for obligations it has already committed to, such as funding for social safety net programs, interest on the national debt and salaries for troops.Wrangling over lifting the borrowing cap has become a fixture, and this year is shaping up to be particularly complicated. Republicans hold the House by a slim majority, and a small but vocal faction of the party has won changes to the rules that govern legislative debate. They have made clear that they want deep spending cuts in exchange for raising the debt limit, and their empowerment could make this round of negotiations more likely to end in disaster.Bank of America analysts wrote in a note to clients this week that a default in late summer or early fall is “likely,” while Goldman Sachs called the possibility that the government would not be able to make good on its bills a “greater risk” than at any time since 2011. When the nation approached the brink in that episode, its credit rating was downgraded and wild market gyrations helped to force lawmakers to blink.A debt default would most likely rattle markets and carry big risks.Andrew Kelly/ReutersIn Washington, the Federal Reserve and Treasury are not publicly speaking about what they could do if an outright default were to happen this time, in part because the mere suggestion they will bail out warring politicians could leave lawmakers with less of an incentive to reach a deal. But they have a series of options — albeit bad ones — for mitigating the disaster if political impasse takes the nation up to or over the brink of default.It is tricky to guess exactly how financial markets will react, both because the timing of any default is uncertain and because many investors are waiting and watching to see what happens in Washington.But former government officials and cautious Wall Street observers warn that the effects could be significant. Markets have grown bigger and more complex since 2011, and an outright default could lead to mass selling, which would impair financial functioning. While the government has done contingency planning for a default, former officials say there is no foolproof option for staving off a disaster.Understand the U.S. Debt CeilingCard 1 of 4What is the debt ceiling? More

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    Powell Says Fed Will Not Be a ‘Climate Policymaker’

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    In a speech on Federal Reserve independence, Chair Jerome H. Powell emphasized that climate change should be addressed by elected officials.Jerome H. Powell, the Federal Reserve chair, said that to retain its independence from politics, the central bank must “stick to its knitting” — and that means it is not the right institution to delve into issues like mitigating climate change.“Without explicit congressional legislation, it would be inappropriate for us to use our monetary policy or supervisory tools to promote a greener economy or to achieve other climate-based goals,” said Mr. Powell, who delivered his comments at a conference held by Sweden’s central bank. “We are not, and will not be, a ‘climate policymaker.’”Mr. Powell’s comments responded to occasional calls from Democrats for the Fed to take a more active role in policing climate change, and to skepticism from some Republicans that it can guard against climate-related risks to the financial system without overstepping and actively influencing whether industries like oil and gas can access credit.While the central bank is working on ways to better monitor climate-related risks at financial institutions, officials including Mr. Powell have been clear that they should not try to incentivize banks to lend to green projects or discourage them from lending to carbon-producing ones.“Addressing climate change seems likely to require policies that would have significant distributional and other effects on companies, industries, regions, and nations,” Mr. Powell said in his remarks.Inflation F.A.Q.Card 1 of 5What is inflation? More

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    Fed Officials Ask How to Better Understand Inflation After Surprises

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    Federal Reserve officials, including Lisa Cook, a board member, are wrestling with how to think about price increases after 18 months of rapid change.NEW ORLEANS — Federal Reserve officials kicked off 2023 by addressing a thorny question that is poised to bedevil the central bank throughout the year: How should central bankers understand inflation after 18 months of repeatedly misjudging it?Lisa D. Cook, one of the Fed’s seven Washington-based governors, used a speech at the American Economic Association’s annual gathering in New Orleans to talk about how officials could do a better job of predicting price increases in the future. Her voice was part of a growing chorus at the conference, where economists spent time soul-searching about why they misjudged inflation and how they could do a better job next time.Fed officials must “continue to advance our understanding of inflation” and “our ability to forecast risks,” Ms. Cook said during her remarks, suggesting that central bankers could update their models to better incorporate unexpected shocks and to better predict moments at which inflation might take off.Her comments underscored the challenge confronting monetary policymakers this year. Officials have rapidly raised rates to try to cool the economy and bring inflation back under control, and they must now determine not only when to stop those moves but also how long they should hold borrowing costs high enough to substantially restrict economic activity.Those judgments will be difficult to make. Although inflation is now slowing, it is hard to know how quickly and how fully it will fade. The Fed wants to avoid retreating too soon, but keeping rates too high for too long would come at a cost — harming the economy and labor market more than is necessary. Adding to the challenge: Policymakers are making those decisions at a moment when they still don’t know what the economy will look like after the pandemic and are using data that is being skewed by its lasting effects.“The pandemic has triggered a lot of changes in terms of how our economy operates,” Raphael Bostic, the president of the Federal Reserve Bank of Atlanta, said during a panel on Friday. “We’re very much in flux, and it’s hard to know for sure how things are going to evolve on a week-to-week or month-to-month basis.”Understanding inflation is key to the thorny policy questions facing the Fed. But determining what causes and what perpetuates price increases is a complicated economic question, as recent experience has demonstrated.Officials have raised rates rapidly to try to slow the economy and bring inflation back under control.Jim Wilson/The New York TimesFed officials and economists more broadly have had a dismal track record of predicting inflation since the onset of the pandemic. In 2021, as prices first began to take off, officials predicted that they would be “transitory.” When they lasted longer than expected, both policymakers and many forecasters on Wall Street and in academia spent 2022 predicting that they would begin to fade faster than they actually did.Given those mistakes, policymakers have begun to suggest that the central bank needs to reassess how it looks at inflation.Inflation F.A.Q.Card 1 of 5What is inflation? More

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    Fed Officials Fretted That Markets Would Misread Rate Slowdown

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    Central bankers remained committed to wrestling inflation lower, and wanted to make sure investors understood that message, minutes from the Federal Reserve’s December meeting showed.Federal Reserve officials worried that inflation could remain uncomfortably fast, minutes from their December meeting showed, and some policymakers fretted that financial markets might incorrectly interpret their decision to raise interest rates more slowly as a sign that they were giving up the fight against America’s rapid price gains.Inflation is beginning to slow down but remains abnormally quick: The Personal Consumption Expenditures price index climbed by 5.5 percent over the year through November, down from a 7 percent peak in June but still nearly triple the Fed’s 2 percent inflation goal. Fed officials still saw inflation as unacceptably high at their meeting last month — and worried that rapid price gains might have staying power.“The risks to the inflation outlook remained tilted to the upside,” Fed officials warned during their December policy meeting, minutes released on Wednesday showed. “Participants cited the possibility that price pressures could prove to be more persistent than anticipated, due to, for example, the labor market staying tight for longer than anticipated.”Such risks set up a challenging year for Fed policymakers, who will need to decide how much more they need to raise interest rates — and how long they need to hold them at elevated levels — to bring inflation firmly under control. The Fed wants to avoid pulling back too early, which could allow inflation to become entrenched in the economy. But officials are also conscious that high rates come at a cost: As they slow growth and weaken the labor market, workers are likely to earn less and may even lose their jobs.That’s why the Fed wants to tread carefully, bringing price increases under control without inflicting more damage than necessary. Officials slowed their rate increases last month, lifting their main policy rate by half a point after several three-quarter-point moves in 2022. Officials forecast that they would raise rates by more in 2023, but their estimates suggested that they were nearing the level at which they might pause: They saw rates climbing to about 5.1 percent in 2023, from about 4.4 percent now.Inflation F.A.Q.Card 1 of 5What is inflation? More

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    Why Japan’s Sudden Shift on Bond Purchases Dealt a Global Jolt

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    The world has relied on ultralow interest rates in Japan. What will happen if they rise?Japan is the world’s largest creditor. At the end of 2021, it held roughly $3.2 trillion in foreign assets, 30 percent more than No. 2 Germany. As of October, it owned over a trillion dollars of U.S. government debt, more than China. Japanese banks are the world’s largest cross-border lenders, with nearly $4.8 trillion in claims in other countries.Late last month, the world got an unexpected reminder of how integral Japan is to the global economy, when the country’s central bank unexpectedly announced that it was adjusting its stance on bond purchases.To those unversed in the intricacies of monetary policy, the significance of Japan’s decision to raise the ceiling on its 10-year bond yields may not have been immediately clear. But for the finance industry, the surprising change raised expectations that the days of rock-bottom Japanese interest rates could be numbered — potentially further squeezing global credit markets that were already tightening as the world economy slows.Since this summer, the Bank of Japan has been an outlier, keeping its interest rates ultralow even as other central banks raced to keep up with the Federal Reserve, which has ratcheted up lending costs in an effort to tame high inflation.As global rates have diverged from those in Japan, the value of the yen has fallen as investors sought better returns elsewhere. That has put pressure on the Bank of Japan to shift the world’s third-largest economy away from its decade-long commitment to cheap money, a policy known as monetary easing.Japan’s deep integration into global financial networks means that there is a lot of money riding on the timing of any move away from that policy, and investors have spent years fruitlessly waiting for a sign.As of mid-December, the overwhelming expectation was that the bank would hold off on any changes until next spring, when Haruhiko Kuroda, the Bank of Japan’s governor and an architect of its current policies, is set to step down.Inflation F.A.Q.Card 1 of 5What is inflation? More