(Bloomberg Opinion) – The consensus appears to be that if Congress does not raise the US government’s debt ceiling by June 1, when the Treasury Department does, markets will implode expected that they are running out of cash to pay the country’s bills.
Treasury Secretary Janet Yellen has said that such a default would trigger a “financial catastrophe”. Moody’s Analytics warns that financial markets are being “turned upside down”. The White House estimates that the stock market would be halved. On Thursday, Jamie Dimon, chief executive officer of JPMorgan Chase & Co., reiterated these concerns: tell Bloomberg said a US default was “potentially catastrophic” and that the panic could spread to markets outside the US.
It’s hard to find anyone who doesn’t agree with this sentiment other than the markets themselves. Financial markets are ruthlessly forward-looking. If they were worried about a default and its consequences, they would fire obvious flares, as they last did in anticipation of the Covid-19 pandemic of 2020, when corporate and municipal bond yields shot up, so did stocks fluctuated wildly and investors fled the crisis to the safety of US Treasury bonds.
None of these distress signals are recognizable today. Corporate and municipal bond yield spreads versus cash, which typically widen 2 to 3 percentage points in normal downturns and double in crises, are stable. The CBOE Volatility Index, the most widely cited measure of stock market volatility, is subdued. And the S&P 500 index trades at a valuation that is at least equal to its historical average and, in some respects, much higher.
Even government bonds that would be directly affected by a US bankruptcy are not showing concern. When borrowers are at risk of default, the first sign of risk is usually an increase in yields as their bond prices fall (bond prices and yields move in opposite directions). It is true that the 1-month Treasury note yield, which is normally closely tracked by the federal funds rate, is currently slightly higher. But otherwise, there’s nothing wrong with Treasury markets. The 3-month T-bill yield remains close to the fed funds rate and longer-dated government bond yields are flat or even slightly lower.
This is not a portrait of markets in deep concern, let alone the possibility of financial disaster looming.
What explains the disconnect between the markets’ steady hand and the gloom emanating from the White House and beyond? The simplest explanation is that markets don’t believe Congress is stupid enough to default. No matter how explicit the partisan threats were in previous debt-ceiling disputes, the bills were always paid. And for good reason: the US is the world’s most creditworthy borrower. Debtors default because they are unable or unwilling to make payments.
However, markets may be signaling something more controversial, namely that even a default would be less damaging, if at all, than feared. In fact, it’s hard to imagine that the US would delay in paying its debt for long, or that such a delay would significantly hurt public company profits or their ability to repay their own debt. For this reason, there is hardly any need for action on the stock and bond markets.
As for Treasuries, they will remain the world’s safe haven no matter what, not only because the US has the largest and most stable economy, but also because Treasuries are the only store of value that investors can agree on.
Ironically, a crisis can only increase investor confidence in government bonds. If a US default shakes markets and sends asset prices plummeting, as many fear, where else can investors safely put their money? Remember, bank deposits are backed by the same government as government bonds, and bank deposits above the state insurance limit are no safer, especially in a crisis, as depositors at regional banks are finding. Sending money abroad may no longer be desirable if the panic spreads beyond US borders, not to mention investors are reluctant to leave home even at the best of times.
Regardless of whether markets are right to keep their cool in the face of the debt ceiling drama, the fear of a default probably poses a greater risk to investors than the default itself. Any drop in markets is likely to be temporary, and those who ignore short-term volatility will continue to benefit from rising asset prices over time. On the other hand, if a default never occurs or has little or no impact, those selling now out of fear might be reluctant to re-enter later at higher prices, making the decision to sit out even more costly and emotionally difficult to correct as the Markets are trending up.
At Berkshire Hathaway Inc.’s annual meeting last weekend, Warren Buffett remarked that a US default would be “probably the stupidest thing Congress has ever done.” “But in the end,” he concluded, “there’s no chance, in my view, that they won’t raise the debt ceiling.” Markets could hardly agree.
More from the Bloomberg Opinion:
- All the debt ceiling Needs are a Deal: Jonathan Bernstein
- Here is How you speak On Raising the Debt Ceiling: Editorial
- In level of debtBiden and McCarthy must choose: David Hopkins
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To contact the author of this story:
Nir Kaissar at [email protected]