Paranoia

Here I sit, watching the news of on again, off again votes on the debt ceiling. Every so often some talking head comes on and attempts to scare the be-Jesus out of viewers that the U.S. government is going to default on its debt obligations. What a load of grade “A” manure.



Prices of U.S. treasuries trended higher today due to concerns that the battle over the raising the debt ceiling is going to harm economic growth. Say what? Debt ceiling concerns are causing investors to flock to the safety of U.S. treasuries. The market is telling us that a U.S. default (an actual failure to pay its debts) is very unlikely. If the U.S. actually defaulted on its public debt, the 2008 financial crisis would look like a picnic by comparison. This is not to say that policymakers are sure to reach an agreement prior to next week’s deadline. However, The U.S. treasury has enough revenue to service its debts if it suspended payments to government programs, pensions and salaries.



Reaching a debt ceiling agreement does not necessarily mean that the economy is out of the woods. As I have said previously, a deal which raises taxes, cuts spending or both would probably hinder growth. As one fixed income strategist told Bloomberg News:





“The market is trading on a combination of anxiety over the debt ceiling overhang and on the concerns that budget cuts could bring. Sentiment seems to be fairly positive for Treasuries.”



What should investors do? The first thing is not to panic. As difficult as it might be for some clients who are avid CNBC viewers, they should avoid panic selling of fixed income assets based on media hype. If one has a well constructed, diversified portfolio, one should be able to weather “the storm” rather well. We would advise investors to take advantage of any weakness the debt ceiling debacle has caused in the fixed income markets, but there really hasn’t been any.





Another day and another "okay" treasury auction. Today the treasury auctioned $29 billion of seven-year notes. The new notes priced to yield 2.28% on stronger demand than seen at the previous auction. The bid-to-cover ratio rose to 2.63 from a prior 2.62. Although the new seven-year note priced higher than an expected 2.256%, today's yield of 2.28% was the lowest yield at auction for a seven-year U.S. treasury since last November's 2.25% due 11/30/17. Indirect bidders, which include foreign central banks, purchased 39.6% of the deal, up from a prior 32.2%.



When taken at face value, today's auction was just alright. However, considering that the U.S. is just days before hitting its current debt ceiling, today's auction was fairly well received. 





Oh, if you think that I am off base that the U.S Treasury will prioritize debt (bond) payments. Check out this story from Bloomberg News:

“The U.S. Treasury will give priority to making interest payments to holders of government bonds when due if lawmakers fail to reach an agreement to raise the debt ceiling, according to an administration official.”


“The official requested anonymity because no announcement has been made. The Treasury has said about $90 billion in debt matures on Aug. 4 and more than $30 billion in interest comes due Aug. 15. Overall, more than $500 billion matures in August.”

This is not to say that a downgrade is out of the question. It is actually very possible and, in my opinion, warranted. That could push long-term yields higher, at least in the near term, but nearly any debt ceiling deal imaginable is likely to include some combination of spending cuts and tax increase. The economic headwinds generated by such a deal will likely keep inflation, and therefore long-term interest rates, relatively low. Any rise of long-term bond yields could be relatively modest.

A downgrade of U.S. treasuries could have a larger impact on credit spreads of municipal and corporate debt. If as U.S. downgrade does occur, look for credit spreads to widen. The lower the credit rating the greater the widening,

That is enough for now. Back to the soap opera that is Washington.