Oct. 10 (Bloomberg) -- Credit derivatives traders are pricing in less than a 2 percent chance U.S. lawmakers will tip the world’s biggest borrower into default by failing to boost the nation’s borrowing capacity.
Even after credit-default swaps protecting against losses on Treasuries for one year doubled this month, they’re still pricing in a 1.4 percent probability the government will fail to meet its obligations, according to data provider CMA. The odds implied by the contract are down from a peak of 1.7 percent yesterday and up from 0.2 percent a month ago.
The swaps are declining amid signs lawmakers could reach an agreement to increase the $16.7 trillion debt ceiling. Treasury Secretary Jacob J. Lew has said Congress must increase borrowing capacity by Oct. 17 or risk a default. House Republican leaders are presenting their members with a proposal to raise limit for six weeks without policy conditions and the proposal could come up for a vote on the House floor as soon as tomorrow.
“People believe at the end of the day, the government will do the right thing and make its debt payments,” Megan McClellan, head of U.S. fixed income at JPMorgan Private Bank, said in a Bloomberg Television interview yesterday. The government gridlock in 2011 taught investors “there will be a last-minute deal,” she said. “The U.S. is not a credit-default situation. We have plenty of money to pay our bills.”
The cost of one-year swaps on the U.S. government have climbed to a mid-price of 53.5 basis points from 34 basis points on Oct. 1 and reached as high as 84 yesterday, according to data from CMA, which is owned by McGraw Hill Financial and compiles prices quoted by dealers in the privately negotiated market. The default odds are based on a pricing model that assumes investors would recover 40 cents on the dollar in a default.
The cheapest Treasuries that would likely be eligible to determine payouts in any default have been trading at almost 83 cents on the dollar, Barclays Plc analysts wrote in an Oct. 9 report. That assumption changes the implied default probability to 3.7 percent, data compiled by Bloomberg show.
Credit swaps, which investors use to hedge against losses or to speculate on creditworthiness, pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt.
Wagers in all credit swaps tied to the U.S. government have increased 12 percent during the past four weeks, according to the Depository Trust & Clearing Corp., which runs a central repository for the market. Banks, hedge funds and other money managers had bought and sold credit swaps protecting a net $3.6 billion of U.S. government obligations as of Oct. 4.
That’s down from $3.7 billion a year ago and from $5.4 billion through Oct. 7, 2011, DTCC data show. There was a net $17.2 billion outstanding of swaps tied to the debt of Italy last week and $9.3 billion on Spain.
Rates on Treasury bills maturing on the debt-ceiling deadline eased today for the first time in six days. Rates on notes due Oct. 17 declined 17 basis points, or 0.17 percentage point, to 0.31 percent. They were negative as recently as last month. The securities are yielding more than the 0.174 percent yield on the one-month London interbank offered rate.
The yield on the benchmark 10-year U.S. Treasury note increased 2 basis points to 2.68 percent, according to Bloomberg Bond Trader prices. That’s down from the high this year of 3 percent on Sept. 6 and compares with the average of 3.53 percent during the past decade.
The U.S. two-year interest-rate swap spread, a measure of debt-market stress, rose 0.75 basis point to 13.38 basis points. The gauge typically widens when investors seek the perceived safety of government securities and narrows when they favor assets such as corporate bonds. The measure, which reached a 2013 low of 11.88 on Oct. 8, has dropped from this year’s high of 19.55 on June 21.
A gauge of U.S. company credit risk fell. The Markit CDX North American Investment Grade Index, a credit-swaps benchmark, dropped 4.6 basis points to a mid-price of 78.7 basis points, according to prices compiled by Bloomberg. The index has averaged 81.8 basis points this year.
The Bloomberg U.S. Dollar Index, which tracks the greenback against 10 major currencies, rose 0.04 percent to 1,013.6. The index has traded in a range of 1,054 and 1,008 the past six months. The greenback gained 0.04 percent to 98.2 yen.
The Standard & Poor’s 500 Index rose 2.2 percent to 1,692.56. The Dow Jones Industrial Average gained 2.2 percent to 15,126.
The CBOE Volatility Index, or VIX, fell 16 percent to 16.48 after this week approaching its closing high for the year of 20.49 in June. That compares with a low of 11.3 in March. Volatility in Treasuries as measured by the Bank of America Merrill Lynch MOVE index fell to 80.1, compared with the average this year is 72.4.
Currency swings as measured by the JPMorgan Global Volatility Index fell to 8.64 versus a 2013 average of 9.38.
West Texas Intermediate crude oil for November delivery rose from a three-month low, climbing $1.40 to $103.01 a barrel on the New York Mercantile Exchange.
Gold futures for December delivery fell 0.8 percent to $1,296.90 an ounce on the Comex in New York. Prices dropped 2.1 percent last week amid speculation that the Federal shutdown that has furloughed 800,000 workers would be short-lived.
Copper futures for delivery in December gained 0.54 percent to $3.2485 a pound, rallying for the first time in four days.
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