Fed's monetary policy mechanics face a crucial test in the event of US debt default

A default on U.S. Treasury debt would be a leap into the unknown for the Federal Reserve’s ability to conduct monetary policy to achieve its job and inflation goals.

That’s because U.S. government bonds are the key to how the central bank sets its short-term interest rate target. Anything that gums up the Treasuries market could scramble those mechanics.

The Fed uses Treasuries for many key operations. Setting a baseline for short-term interest rates via its reverse repo facility in effect borrows cash from money market funds in transactions collateralized with government bonds. The Fed can also borrow or buy Treasuries to keep its federal funds rate at the targeted level.

Treasury Secretary Janet Yellen has said the government could run short of the funds needed to pay all its bills as soon as early June if the debt ceiling is not raised. The White House and Republican lawmakers in Congress are locked in tense negotiations with little sign they were close to a deal that would avoid a default that could unleash chaos in the global financial system.

Read More : Fed’s monetary policy mechanics face a crucial test in the event of US debt default