Wednesday, October 2, 2013

Market beginning to price in the risk of US technical default

We've seen this movie in 2011. Washington's inability to raise the debt ceiling could make the current government shutdown look like child's play. Yet just as before, the saber rattling is on.
FoxNews: - Some Republicans want to use the debt-ceiling vote to extract additional concessions, much of which pertain to cutting spending.

"I'm not going to raise the debt ceiling yet again without addressing why we're in debt," Sen. Lindsey Graham, R-S.C., told Fox News. He and other Republicans argue that these spending cuts are critical in order to bring the federal budget back to a sustainable level and, ultimately, start to reverse the seemingly inexorable rise of the national debt.

Some Republicans, though, also want to use the debt-ceiling vote to extract concessions over ObamaCare. From their standpoint, it's for the good of the economy.

Rep. Ted Poe, R-Texas, like many of his colleagues, said the overwhelming message he hears from business owners is their dislike of Obama's health care overhaul, which is at the center of Congress' impasse and the government shutdown. Likewise, Rep. Steve Chabot, R-Ohio, said he mostly hears business owners complain "about the negative effects of `Obamacare' upon their ability to do business and hire people."
Hopefully Rep. Chabot understands that any negative effects of Obamacare on business owners (discussed here) will be dwarfed by the global chaos created from the US government's inability to borrow. You don't solve the US deficit problem by threatening a technical default.

Just as in 2011, with the US debt ceiling date approaching, longer dated treasury yields have moved lower. What the media tends to miss however is that the short end of the curve is doing the opposite. The yield on one-month bills has increased. That's because most investors think the technical default will result in merely a short-term delay in payments by the US Treasury. Which means that the one-month bill holders may not get their principal back on time - causing the 1m bill yields to rise. A delay in longer maturity securities is not as critical to pricing. But yields on other T-bills will also rise if the expected delay in payments extends beyond a few days.

The expectation of any default being simply a delay of payments doesn't mean one could take this situation lightly. Even a delay in repaying the one-month bill will send shock waves through the global markets. It could even endanger the functioning of various banking payment systems that rely on predictable treasury payments.
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