The Threat of a U.S. Debt Default Is Propping Up U.S. Debt

Photograph by Diane Macdonald

The U.S. government is edging closer to the precipice of defaulting on its debt for the first time in history. What investments have risen in these harrowing days? Would you believe the answer is—U.S. government debt?

Stocks have declined in the face of the potential default and, separately, a shutdown of nonessential government services, with the Dow Jones industrial average falling in nine of the last 12 trading sessions. Meanwhile, Treasuries have increased in value. The yield on 10-year U.S. bonds fell to 2.616 percent at midday on Oct. 7, from 2.995 percent on Sept. 5. (Yields go down as bond prices go up.)

“It’s a strange situation where the bigger the risk of the debt ceiling gets, the more Treasuries seem to benefit,” John Wraith, a fixed-income strategist at Bank of America, told Bloomberg News.

A major factor here is the role of the Federal Reserve. The central bank surprised much of Wall Street in mid-September when it announced that it would not ratchet down its stimulus program, in the form of $85 billion in monthly bond purchases. For debt investors, that extraordinary activity outweighs the possibility that Republicans in Congress will actually allow the Treasury to run out of money and miss payments to its creditors.

“Most people look at it and say, ‘What’s a bigger impact on my life—the Fed buying $85 billion of securities a month, or the potential for a day or two delay on interest payments?’” says Drew Matus, deputy chief U.S. economist at UBS Securities. “I think most people in the marketplace would argue the Fed is more important.”

Treasuries also benefited the last time the U.S. veered dangerously close to default, in the summer of 2011—before the Fed began its round of “quantitative easing” in the fall of 2012. Investors back then were rewarded for their belief that Congress would reach an agreement before exposing the global financial system to chaos. For a reality check on just how bad a default could be today, read this Bloomberg News piece on how the 2008 financial crisis would be dwarfed by “an economic calamity like none the world has ever seen.”

There’s still a grave chance the bond market will take a hit as the Oct. 17 deadline—as set out by Treasury Secretary Jack Lew—approaches. “If there was a dance, the equity market would be leading and the fixed-income market would be following,” Matus says. A massive selloff in stocks, akin to the almost 800-point drop that forced the House to pass the Troubled Asset Relief Program in 2008, could reverberate in fixed income, he says.

    Before it's here, it's on the Bloomberg Terminal. LEARN MORE