US debt-ceiling risk for markets is underpriced: Wells Fargo

Neither party in Congress is signaling it’s ready to back down.
Image: Moneyweb
Wall Street strategists are starting to conclude that financial markets are looking too sanguine about the latest showdown over the U.S. debt ceiling, and they warn of the risk of turmoil ahead.

The risk premium already built into Treasury bills, a proxy for speculation over a potential U.S. default, is likely to grow, according to Wells Fargo strategists. And they say the yen, a haven during market turbulence, is probably going to outperform if the impasse drags on close to the so-called X-date for when the government will run out of money.

Treasury Secretary Janet Yellen says she views the drop-dead date as Oct. 18. The risk premium in bills is currently 10 to 12 basis points, with Oct. 21 and Oct. 26 bills peaking around 13 basis points, according to Wells Fargo, which expects the gap to approach 20 basis points.

“The risk this debt-ceiling showdown roils markets like it did in 2011 is underappreciated,” Wells Fargo strategists Zachary Griffiths and Erik Nelson wrote in a note Tuesday. “We mean this from the perspective of brinkmanship by both Democrats and Republicans.”

The 2011 saga resulted in S&P Global Ratings downgrading the U.S. from AAA, deepening a decline in long-term Treasury yields and U.S. equities that was also fueled by the European debt crisis.

Wells Fargo said it doubts a ratings company will downgrade the U.S. However, Fitch Ratings said last week that delayed or defaulted payments by the Treasury, even on items other than Treasury securities, “would likely undermine the U.S.’s ‘AAA’ status.”

Market response
If Fitch were to downgrade the U.S. rating before a resolution on the debt ceiling was in place, the 10-year yield would tumble 15 to 20 basis points in a day or two, and the gap between 2- and 10-year yields would narrow by 10 to 15 basis points, Wells Fargo said.

The yen is likely to benefit from any market turmoil, and “clients with short-term (one month or less) JPY exposure or interest should position for yen strength,” the Wells Fargo analysts wrote.

Yellen on Tuesday echoed President Joe Biden’s message from Monday, warning that the government is at risk of running out of options to stay within the legal limit on its debt. With the clock ticking, neither party in Congress is signaling it’s ready to back down.

“I vividly remember the 2011 and 2013 debt-limit standoffs from back when I was still at the Fed, and I had been saying that this one is the worst SINCE those episodes,” RBC strategist Blake Gwinn wrote in a note Tuesday. “I have to say I think it is clearly worse.”

© 2021 Bloomberg L.P.

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Here we go again, the USA lives the grandeur lifestyle and when they cannot pay we all have to pay for their parties.

Put a fence around the USA and let them go.

The USA wags their finger at other countries for their debt to GDP, whilst their debt to GDP is at about 130%. Fix your own situation first before lecturing others.

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