What Markets Think About the Looming Debt Ceiling Showdown

Investor angst in financial markets is suggesting Congressional efforts to raise the nation’s debt ceiling will play out more like the lesser of two recent showdowns.

Source: Bloomberg

Financial markets are suggesting the political drama surrounding Congressional efforts to raise the nation’s debt ceiling will play out more like the lesser of two recent showdowns.

Investor angst, as measured by the CBOE Volatility Index, known as both the VIX and the fear index, is below the levels experienced during 2011 and 2013 confrontations, even as lawmakers face of deadline of a little more than a month to reach an agreement.

The protracted battle in 2011 led S&P Global Ratings to downgrade U.S.’s sovereign debt for the first time. In 2013, Congress struck a last-minute deal to end a four-week standoff that economists say took a notch out of economic growth and delayed the Federal Reserve from tapering its bond purchases. This go around could tweak the Fed’s monetary agenda again.

The Fed last month signalled that it intends to kick off the reduction of its $4.5 trillion balance sheet in September. It may delay the move if the Treasury’s borrowing authority isn’t extended, according to Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey.

How much investors are willing to pay for insurance against the chance politicians drop the ball and cause Treasury to default on its obligations — shattering the previously seen unshakable full faith and credit of U.S. debt in the process — is another litmus test for investors’ unrest.

While the cost to protect against a U.S. default over the next five years through credit-default swaps has jumped this month, the level is a fraction of record measures seen in 2011 and trails the creep higher that took place in 2013. The CDS trade at 26 basis points, meaning it costs 26,000 euros ($31,000) to insure 10 million euros worth of Treasuries against default.

Investors are again avoiding the shortest government debt securities that mature around the possible default date, while long-term Treasuries appear to be beneficiaries of the uncertainty.

Even so, the overall added costs to taxpayers from the rise in Treasury rates in 2013 ranged from $38 million to more than $70 million, according to a study by the Government Accountability Office. In the 2011 event, it caused a $1.3 billion increase just in that fiscal year alone.

So far debt-ceiling fears are playing out like 2013 when they mostly put downward pressure on 10-year Treasury yields. That comes as the debt ceiling problem is being complicated by threats from President Donald Trump last week to shut down the government over a budge impasse if politicians don’t fund his boarder wall.