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(Bloomberg Opinion) — The consensus appears to be that markets will implode if Congress doesn’t raise the US government’s debt ceiling by June 1, which is when the Treasury Department expects to run out of cash to pay the nation’s bills.
Treasury Secretary Janet Yellen has said that such a default would trigger a “financial catastrophe.” Moody’s Analytics warns that financial markets would be “upended.” The White House estimates that the stock market would get cut in half. On Thursday, JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon echoed those concerns, telling Bloomberg that a US default is “potentially catastrophic” and that panic could spread to markets outside the US.
It’s hard to find anyone who disagrees with that sentiment — except markets themselves. Financial markets are ruthlessly forward looking. If they were concerned about a default and its aftermath, they would fire obvious flares, as they did most recently in anticipation of the Covid-19 pandemic in 2020, when yields on corporate and municipal bonds spiked, stocks gyrated wildly, and investors fled to the safety of US Treasuries.
None of those distress signals are evident today. Yield spreads on corporate and municipal bonds relative to cash, which typically rise 2 to 3 percentage points during normal downturns and double that during 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 at least in line with its historical average and by some measures much higher.
Not even Treasuries, which would be directly implicated in a US default, are showing any concern. When borrowers are in jeopardy of default, the first sign of danger is usually a spike in yield as their bond prices tumble (bond prices and yields move in opposite directions). It’s true that the yield on one-month Treasury bills, which normally tracks the federal funds rate closely, is modestly higher than that now. But nothing else is amiss in Treasury markets. The yield on three-month T-bills continues to hug the fed funds rate, and yields on longer-term Treasuries are flat or even down slightly.
That’s not a portrait of markets that are worried about much, let alone a potentially imminent financial catastrophe.
What explains the disparity between the steady hand of markets and the gloom coming from the White House and beyond? The simplest explanation is that markets don’t believe that Congress is foolish enough to default. No matter how pointed the partisan threats during previous debt-ceiling showdowns, the bills always got paid. And for good reason: The US is the most creditworthy borrower on the planet. Debtors default because they’re unable — not unwilling — to make payments.
But markets may be signaling something more controversial, namely that even if a default were to happen, it would be less damaging than feared, if at all. Indeed, it’s hard to imagine the US refusing to pay its debts for long or that such a delay would meaningfully curb public companies’ profits or their ability to repay their own debts. By that reasoning, there’s little need for stock and bond markets to react.
As for Treasuries, they will remain the world’s safe haven no matter what happens, not only because the US boasts the biggest and most stable economy but also because Treasuries are the only store of value investors can agree on.
Ironically, a crisis may only deepen investors’ faith in Treasuries. If a US default roils markets, causing asset prices to plummet as many fear, where else can investors safely park their money? Remember that cash in the bank is ensured by the same government behind Treasuries, and bank deposits above the federally insured limit are no safer, particularly in a crisis, as depositors at regional banks are discovering. Moving money overseas may not be any more desirable if panic spills beyond US borders, never mind that investors are reluctant to leave home in the best of times.
Whether or not markets are right to keep cool about the debt-ceiling drama, fear of default is probably a greater risk to investors than default itself. Any decline in markets is likely to be temporary, and those who ignore the short-term volatility will continue to benefit from rising asset prices over time. On the other hand, if a default never materializes or turns out to have little or no impact, those who sell in fear now may hesitate to get back in at higher prices down the road, making the decision to sit out ever more costly and emotionally difficult to correct as markets trend higher.
At Berkshire Hathaway Inc.’s annual meeting last weekend, Warren Buffett remarked that a US default “would probably be the most asinine act that Congress has ever performed.” “But in the end,” he concluded, “in my view, there’s no chance that they don’t increase the debt ceiling.” Markets couldn’t agree more.
More From Bloomberg Opinion:
- All the Debt Ceiling Needs Is a Deal: Jonathan Bernstein
- Here’s How to Talk About Raising the Debt Ceiling: Editorial
- In Debt Standoff, Biden and McCarthy Must Choose: David Hopkins
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To contact the author of this story:
Nir Kaissar at [email protected]
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