Talks on the US debt ceiling stalled late Tuesday, with negotiators meeting at the White House making no significant progress on lifting the $31.4 trillion limit before the Treasury Secretary Janet Yellen’s June 1 noncompliance notice.
Yet while global stocks are in retreat (equity investors are reducing risk in light of bitterly partisan talks), bond investors have shown little concern about the so-called catastrophe risk they face the economy in the event that the United States ran out of cash and became unaccredited. your debts in the coming weeks.
This last description, of course, represents the path debt ceiling the talks, and their possible consequences, have been characterized as much by the two sides of the negotiations as by non-financial means.
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“It’s Congress’ job [raise the debt ceiling]” Yellen said last month. “If they don’t, we will have an economic and financial catastrophe that will be of our own making.”
A truer reflection of the risks, however, can be found in both a sharper dissection of the nature of the impasse and the bond market’s muted reaction, at least to this point.
“No one in the market really believes that a lasting catastrophe will come from the debt ceiling because it won’t,” said David Bahnsen, chief investment officer at Bahnsen Group, the wealth management firm in Newport Beach, California.
“It’s pure political theater along the way, and in a sense the market can become a linchpin for one or both sides of the political aisle to use to help negotiate,” he added.
Currency sovereignty negates the risk of default
First, it’s worth noting that the US will not run out of money on June 1st. The US controls its own currency, in terms of minting its creation, determining its value, and setting the interest rate around which it is traded in international markets.
Known as “monetary sovereignty,” this ability effectively ensures that the United States cannot pay off its debts in any meaningful way, as it only needs to print new money (or issue new debt) to pay its bills.
This means that what is at stake on June 1 is an administrative and political hurdle, not an existential crisis.
The Treasury will not be able to authorize any additional payments without approval from Congress, which has constitutional control over the nation’s purse strings, now that the $31.4 trillion ceiling, last raised in December 2021, is about to arrive.
Almost all of the world’s advanced economies have abandoned, or refused to introduce, the idea of a fixed debt limit in the first place, preferring instead to use debt as a percentage benchmark. GDP.
This gives governments the flexibility to add more debt when the economy is weakening (in order to spur growth) while cutting it when the economy is in good health.
Limiting global debt to $31.4 trillion, or any amount for that matter, removes that flexibility. It also creates a strange fiscal paradox in which lawmakers can approve new spending (or tax cuts) in one session, only to refuse to raise the debt needed to pay for it in another.
Absurd as it may seem, however, it does not create the kind of doomsday risk described by the political actors involved in the debate.
“It’s important to note that even if we reach date X (June 1) without new debt ceiling legislation, the risk of the government technically defaulting on its debt remains low,” Jason said. Pride and Michael Reynolds of Glenmede’s Investment. strategy
“If the X date is reached before a debt ceiling increase, the government can prioritize interest payments over its outstanding debt. This avoids default while providing additional time for congressional leaders to reach an agreement”.
And this has been shown in the market’s reaction to the crisis which has been simmering.
Foreign buyers chase a 2-year auction as a safe haven
Yields on benchmark 2-year Treasuries, which move in the opposite direction to prices, have fallen from 4.4% earlier this year, when debt ceiling risks began to materialize, up to around 4.285% today.
Now, while it’s true that bond yields are higher than they were in early May, the moves haven’t reflected any real concerns about near-term default.
In fact, the US Treasury sold $42 billion in new 2-year notes yesterday, securing a performance of 4.3%. The Treasury saw foreign investors withdraw 68.2% of the entire auction, the highest level since 2009 and the second highest on record.
Thus, not only are foreign investors unconcerned about the risk of default, but they are willing to bid competitively with each other to find a safe haven of value while helping to finance American spending.
JPMorgan analysts also noted last week that “if perceived progress toward a deal slows in the coming days, that would be bullish” for Treasury bond prices. It would reduce yields in a flight-to-safety trade that, counterintuitively, would lower the government’s borrowing costs.
Bank of America’s survey of fund managers, released last week, found that 71% of respondents expected a resolution on the debt ceiling before the June 1 “X date” and were far more concerned for recessionrate increases and commercial real estate risks rather than on a US default.
Markets, however, have demanded a premium for short-term government lending, with the yield on 1-month Treasuries rising to a record 5.892% in overnight trading, to offset the added risk that the U.S. they can’t to meet the full payment liability at the beginning of June.
But higher yields aren’t just a reflection of risk, as bets for another Fed rate hike are accelerating after strong April retail sales data, a robust labor market and improving of the conditions in the banking sector.
CME Group’s FedWatch, in fact, suggests a 49.1% chance of a July rate hike, up from just 19.8% a month ago.
“A deal on the debt ceiling is a certainty and all market players know it,” Bahnsen said. “The only problem along the way is short-term traders playing the ebbs and flows of the process…and we call that noise.”
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