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Friday, September 24, 2021
Rethinking the U.S.'s AAA-credit, and its 'risk free' debt
We all know that Washington’s deeply unserious Kabuki dance, also known as raising the debt ceiling, comes with very serious consequences.
Markets generally ignore the partisan squabbling between D.C.’s warring factions — at least until the very last minute when the outcome is no longer in doubt.
However, the uncertainty does create market volatility. And most reasonable people agree that the entire spectacle is unbecoming of the leadership of the world’s largest economy, home to the deepest and most liquid market, and the largest reserve currency.
So, what to expect as Washington hurtles toward another crisis-driven deadline? Past debt ceiling fights might offer some form of prologue for what investors can expect as the latest debate plays itself out.
Solita Marcelli, UBS Global Wealth Management’s CIO, noted on Wednesday that during the polarizing 2013 vote, shorter-dated Treasury debt fell prey to selling, helping to drive up yields on government and commercial paper and pushing the S&P 500 lower by 4%.
Treasuries have already come under selling pressure after the Federal Reserve’s policy decision on Wednesday, and any suggestion that the U.S. could default could scramble stock prices and bond yields alike.
“Unlike a delay in raising the debt ceiling, temporary government shutdowns generally do not trigger much market volatility. Still, the path to resolution of these multiple issues remains murky, and we cannot rule out some modest short-term market volatility in the coming weeks,” Marcelli added.
As many observers have pointed out, however, the debt ceiling is an avatar of a political crisis instead of an economic one. The government could shut down, or in the most extreme scenario, stop paying some of its bills.
That said, the U.S. is hardly Argentina, which was the infamous epicenter of what was at the time the largest sovereign debt default in history 20 years ago, or Greece — whose 2011 debt restructuring roiled markets and prompted one Fed governor to fume that the country was “holding the world hostage” to its problems.
America can easily print more money, and issue more debt that countries and institutions would likely continue buying. But at least one unanswered question lingers in the background. However unlikely, would any of the ratings agencies have the temerity to do what S&P did back in 2011, when it shocked the world by snatching away the U.S.’s triple-A credit rating?
“The U.S. retains some exceptional credit strengths, and its ratings are underpinned by its high degree of economic, institutional and financial resilience,” Thomas R. Torgerson, co-head of sovereign ratings at DBRS Morningstar, wrote in an opinion earlier this month.
“However, DBRS Morningstar considers brinksmanship with the debt ceiling to be a dangerous game — atypical of a 'AAA' rated sovereign,” he added.
Against a backdrop of extreme political polarization, the drama unfolding on Capitol Hill, combined with Uncle Sam’s addiction to spending money he doesn't actually have, makes investing in the U.S. more than a little politically risky — though not nearly as much as in China.
As such, it also casts a pall over the idea that U.S. Treasury debt can keep enjoying its status as the safest of safe-haven assets, which means it has no risk premium.
Brad McMillan, CIO at Commonwealth Financial Network, a private registered investment adviser-broker/dealer, explained it best:
“U.S. Treasury debt is universally considered a risk-free asset. But if the government doesn’t pay its obligations — if it defaults — then that risk-free status comes into question,” McMillan wrote this week.
“As the foundation of the global financial system, any default could shake that whole structure, rattling markets. On a more extended time frame, as the U.S. credit score goes down, the interest rates we pay could go up. So, this is a bad thing. While this is definitely a manufactured crisis, it is also potentially a real one,” he added.
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