After the week that passed did not bring a solution on the debt ceiling in the US, nervousness is beginning to creep closer and closer to investors before trading opens again on Monday morning.
In the market, the price of credit default swaps (CDS), instruments that allow investors to secure government bonds against default, has skyrocketed recently. The US CDSs now cost more than for countries such as Greece and Brazil, a clear sign of the fear that has gripped the market.
– The bond market is certainly concerned. Credit swap defaults have not been traded at such high prices for at least 15 years. From this it is obvious that the bond market is pricing in a definitive risk of default, says Alexander Miller, investment director at Odin Forvaltning.
– The consequences are enormous
The debt ceiling was already reached in January, but the US has covered current debt expenses by bringing in money from other items. In not many working days, however, the coffers run out and then additional loans must be taken out to service the debt the country already has.
The US has never gone into default before, although it was only a hair’s breadth away in 2011. Then the parties agreed to raise the debt ceiling just two days before the deadline. The consequence was a downgrading of US government debt from triple A to double A, while there was also a marked stock market fall for the broad S&P 500 index.
Before the weekend, the Treasury Department in the United States stated that, as of May 10, it “only” had $88 billion on hand for use in extraordinary circumstances.
If 1 June passes without an agreement between the Democrats and the Republicans, it will mean a technical default for the US national debt. This will mean, among other things, that owners of the most short-term government bonds will risk not being paid.
– You cannot imagine anything unimaginable. We have too little experience to be able to predict what the effect of such a situation will be. If that happens, the consequences are enormous in relation to the ripple effects it will have for all markets throughout the world which are quite dollar-centric and dollar-dominated, says Olav Chen, head of allocation and global interest at Storebrand Asset Management, to DN.
The dollar is considered the world’s safest currency. If the US defaults on its national debt, it could weaken the dollar’s status as a reserve currency in the long term, but in the short term the dollar may still strengthen, as it often does in times of great uncertainty, believes Chen.
– There is still a big scratch in the paint if there is a default, since the dollar can no longer be considered the safest thing there is. There is also some doubt as to whether it can be used as security always and in all cases without risk.
On tiptoe
The market is therefore on tiptoe when President Joe Biden and his government will have meetings with the Republicans next week. There has been talk of finding a long-term solution rather than a short-term clarification which will mean that the debt ceiling will again be approached after the summer. Republicans have indicated they want a sharp cut in government spending to agree to raise the debt ceiling.
Given US government bonds’ reputation as one of the safest things to invest in, any statements about the debt ceiling in the coming weeks will be scrutinized.
Finance Minister Janet Yellen warned earlier this week of the consequences if the debt ceiling is not lifted.
– If Congress does not find a solution, it will affect our credit rating. Something will be defaulted if the debt ceiling is not lifted, whether it is government bonds or social security recipients. That hasn’t happened in the United States since 1789, she said.
No fear to trace in the stock market
Where fear has increased in the bond market, the interest rate and equity markets have seemed unaffected by the fact that the deadline is fast approaching. For the leading indices on Wall Street, there were small changes from day to day throughout the week, while in the interest rate market the two- and ten-year interest rates have fallen somewhat from the levels at the beginning of the month.
It is currently unknown exactly how a technical default of US government debt will affect the markets, but for now investors do not seem to be significantly concerned. The VIX index, or the fear index as it is often called, has had a downward trend in recent weeks.
– The stock market is apparently very little worried. Even the part of the stock market that depends on government funding has done as little as the rest of the market, says Miller.
He believes it is not easy to say what is the reason why the stock market and the bond market react very differently to possible default.
Chen explains the stock market’s unshakable calm with what he refers to as a clear “tail risk”.
– It is something that can occur with a very low probability, but if it does, the consequences are enormous. The fact that the stock market has not yet started to price in the risk of default is because you feel you still have quite a bit of time. One thinks that it will work out in the end and that this is once again just a political game.
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2023-05-14 18:18:42
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