Credit-default swaps insuring against losses on U.S. Treasuries cost about half as much as during the last Congressional showdown on speculation that lawmakers will agree to raise the nation’s debt limit by Oct. 17.
Swaps contracts dropped three basis points to 31 basis points today as Congress remains mired in a partisan deadlock. That compares with a peak of 56 basis points in July 2011, when a political standoff threatened to shutter programs and delay bond payments, according to data compiled by Bloomberg.
The amount of debt protected by default swaps has fallen to $3.1 billion dollars from $5.6 billion two years ago and compares with $13 billion of outstanding insurance on German bunds. Failure by President Barack Obama and Congressional leaders to reach agreement may force the government to delay bond payments, causing a credit event that would trigger insurance payouts.
“We’ve been here before and there’s this confidence that no matter how divided and extreme Congress is, we’re not going to end up with a U.S. default,” said Steven Englander, global head of G-10 currency strategy at Citigroup Inc. in New York. “Every time we go there, the assumption is that it gets resolved closer to the deadline.”
In a default, the derivatives would be settled based on the value of bonds that is determined at an auction. While U.S. Treasury debt typically trades at or above par, some longer-dated bonds are quoted below face value.
The government’s $42 billion of bonds due in November 2042 are quoted at about 82 percent of face value, meaning swaps buyers would be paid the difference to settle the contracts.
There are 847 credit-default swaps contracts linked to U.S. debt outstanding, according to the Depository Trust & Clearing Corp. Ten trades covering $290 million of Treasuries took place in the week through Sept. 20, compared with a daily average of 12 trades covering $175 million from June 2011 to September 2011.
The debt ceiling debate is unlikely to change the U.S. government’s AA+ grade, Standard & Poor’s said yesterday. The world’s biggest economy lost its top AAA standing with the rating company in July 2011.
“You can have a gentle government shutdown,” Englander at Citigroup said. “It’s hard to have a gentle default.”
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