Hang fire on debt ceiling panic
The deadline for Congress to pass the new, revised debt-ceiling is drawing closer. Markets appear to be reasonably sanguine about the prospects for a passage of the necessary legislation, albeit with all the usual howling, wailing and gnashing of teeth to be expected when such issues come onto the political agenda. As of Friday, 10-year Treasuries made a new low for the year at around 2.86%, gradually moving in on being 100bp lower than the high yield for the year set in February at 3.74%. Clearly no sign of panic.
However, that does not stop the papers from filling column inches with dire predictions of what would happen if the debt ceiling were not to be raised and the ratings agencies made good their threat to downgrade the debt of Uncle Sam. The latest in a long line appeared in this morning’s FT where it cites S&P Valuation and Risk Strategies, a research group owned by, but maintained at an arm’s length from, the ratings business. The inference is that yields on treasuries would rise by around 30bp across the curve. Moreover, they add that a re-rating would wipe US$100bn off the value of outstanding treasury debt. The article says: “A ratings downgrade that results in higher bond yields and lower prices could also mean the US Treasury paying $2.3bn–$3.75bn a year more in interest on financing a $1,000bn budget deficit.” It then goes on in its concluding paragraph to state: “A ratings downgrade applied across all Treasury maturities could raise the cost of financing an annual budget deficit of $1,000bn by an additional $20bn”.
To be perfectly honest, I haven’t got a clue what they’re on about and, unless I’m mightily mistaken, nor have they. The debt ceiling issue is gloriously contentious and one which offers second and third-rate politicians a massive opportunity to sell their vote for promises of preferential treatment for their constituency. This is proper pork barrel politics and with the campaign for November 2012 already beginning to hot up, this is supreme opportunity for incumbents to make a good impression on the home front.
We might, as Europeans, find this sort of brinkmanship a tad childish (which it is) but there is no doubt that the Greek situation has also brought out some pretty dubious performances from our own leaders with the difference that they try, as far as possible, not to wash all their dirty laundry in public.
Mind you, seeing Treasuries rally is not entirely surprising as investors of all hues try to exit risk. High-yield debt, which had appeared to be the last game in town through the first half of this year, has lost its sparkle and high-yield funds are now suffering net outflows. However, the Street has no desire to buy paper which it reckons it can only lose money on, so bids are pulling back and illiquidity is increasing.
Although not wanting to draw comparisons with 2008, we are in that space where holders want out – but where there is as yet no desire by bargain hunters to step in. This vacuum is very painful, especially for tightly controlled investors who have to prove to their auditors that they traded at market prices. The price screens, which they print out as proof of the fairness of the price, currently mean nothing but they are blocked and cannot simply hit the best price they see.
I recall over 20 years ago when Reuters was the font of all knowledge and Germans, especially Germans, would always contend: “Ja, but ze price on Reuters is …” To which I customarily would reply: “Then why don’t you call Reuters and ask them for the offer.” These periods of illiquidity frequently end in a sharp step downward in pricing as the Street seeks levels where buyers care and no longer gives a fig for what sellers intentions are, which always causes extreme frustration as it becomes clear how little investors really know of how market-making works.
Alas, we are in the week which brings us month-end, quarter-end and half-year end. Ideally, nobody will try to be too clever and upset the apple cart before Thursday night. Life’s hard enough as it is.