Bonds Show Investors Don't Have Concerns About Risk of U.S. Fiscal Crisis
As the political debate over budget cuts in Washington threatens to bring the government to a partial shutdown, bond markets are showing little concern about the nation’s fiscal health.
Yields on two-year Treasury securities fell one basis point to 0.82 percent at 9:07 a.m. in New York, below the average yield of 2.59 percent in the last decade, according to Bloomberg Bond Trader prices. Bond prices reflect expectations that lawmakers will resolve differences over the budget and avoid a crisis of confidence in U.S. assets, said John Lonski, chief economist at Moody’s Capital Markets Group.
“I just don’t see where that is exerting much influence over the pricing of financial assets,” Lonski said in a telephone interview from his New York office. Investors foresee that “when you come to the edge of the precipice, a more rational approach should prevail,” he said.
The difference between yields on two-year notes and Treasury Inflation Protected Securities, a gauge of expectations for consumer prices over the life of the debt, was 2.56 percentage points today, lower than its average of 2.62 percent in 2005 and 2006, the two years before the financial crisis erupted in 2007.
Investors are unconcerned because “it isn’t a genuine fiscal crisis,” said Wayne Abernathy, executive vice president of the American Bankers Association, who served as assistant Treasury secretary for financial institutions in the administration of President George W. Bush. “We’re talking about debate over finishing up the last pieces of this year’s budget. I think if we were talking about a fiscal crisis that affected the debt limit, that’s a very different issue.”
Calm in financial markets contrasts with the drama in Washington as Republicans and Democrats blame each other for an impasse over proposed cuts intended to narrow a deficit that’s projected to rise to a record $1.6 trillion this year. Current spending authority for government operations is set to expire tomorrow.
“The Republican leadership has the Tea Party screaming so loudly in its right ear that it can’t hear what the vast majority of the country demands,” Senate Majority Leader Harry Reid of Nevada said two days ago.
“We urge you to reconsider your reckless, partisan strategy of shutting down the government,” a group of 90 House Republicans wrote to Reid.
The administration of President Barack Obama is preparing for a partial shutdown of operations if Congress doesn’t act, which would suspend Internal Revenue Service audits and federal small-business loan processing, as well as government guarantees of some mortgages, according to an official who briefed reporters on the condition of anonymity.
The Treasury Department will conduct its regular schedule of securities auctions in the event of a shutdown, another government official said this week. The Treasury borrows money through the weekly sales of bills, monthly sales of longer-term notes as well as 30-year bonds to fund government operations.
Obama said a meeting last night with Congress’s top two leaders advanced efforts to reach an agreement. “We should be able to complete a deal and get it passed and avert a shutdown,” Obama said in brief remarks to reporters after he conducted the White House session with House Speaker John Boehner, an Ohio Republican, and Reid.
The showdown over this year’s budget is a prelude to a larger battle over spending in the coming fiscal year and beyond. A blueprint unveiled by House Budget Chairman Paul Ryan, Republican of Wisconsin, would cut more than $6 trillion over the next decade from Medicare, Medicaid, food stamps and scores of other programs.
“We are on a path of economic ruin,” Ryan said yesterday at a congressional hearing. “Let’s get on to the business of saving this country and getting this debt paid off while we can still do it on our terms.”
By contrast, interest-rate swaps are showing confidence in the nation’s fiscal future. Swap spreads are used as a gauge of investor perceptions of credit risk.
The difference between the rate to exchange floating for fixed-interest payments for two years and the comparable Treasury yield, known as the swap spread, was 17 basis points today, down from 21.5 basis points at year-end and below its average of about 45 basis points in the last decade.
The market may have “a little bit of false optimism,” said Michael Barr, who left in December as the Treasury’s assistant secretary for financial institutions to return to his academic career at the University of Michigan in Ann Arbor.
“I think there’s a mispricing of the risk involved if the impasse does occur,” Barr said. “The crisis over a government shutdown is consequential. The crisis over the debt ceiling would be devastating.”
Treasury Secretary Timothy F. Geithner this week told lawmakers that the U.S. will reach the $14.29 trillion limit on its ability to borrow on May 16 unless Congress raises the ceiling.
“At some point the madness has to stop,” said Mitchell Stapley, chief fixed-income officer for Fifth Third Asset Management, which oversees $22 billion.
“For the first time we’re getting to the point where people are saying we’re going to start talking about” a credible budget-reduction plan, said Stapley, who is based in Grand Rapids, Michigan. “That’s why the market’s not freaking out about this.”
Chief executive officers’ confidence in business conditions over the next year is also improving, as measured in a monthly survey by Chief Executive Magazine. The measure rose above a level indicating “good” in January for the first time since July 2007 and climbed again in February.
The Standard & Poor’s 500 Index rose 0.2 percent to 1,335.54 yesterday, bringing its gains for the year to 6.2 percent.
Should the markets start tumbling in response to concerns about a U.S. fiscal crisis and a government shutdown, Congress would be forced to act, Lonski said.
“There would be too many people calling their Congressmen, complaining about the drop in their 401Ks,” he said.
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