Tuesday, July 26, 2011

Monday Night Smackdown

As I talked to clients and colleagues this morning, it appears that I must have been one of the few people to watch President Obama and Speaker Boehner last night blame the other party for the looming debt crisis.

Maybe it's just that I need more hobbies to busy myself at night, or maybe the complacency of my immediate circle of friends is more appropriate.

There is some suggestion that the White House has overplayed its hand on this one. Andrew Ross Sorkin writes in this morning's New York Times that maybe the August 2 deadline isn't so hard-and-fast after all:

The administration may have made a strategic mistake in warning too soon that the market would react negatively. It ultimately undercuts the government’s negotiating position because the doomsday scenario has not played out, even though the deadline is fast approaching.

“They have lost all credibility,” said Neil M. Barofsky, the former special inspector general for the Troubled Asset Relief Program. “It’s so typical of the way Treasury and the Fed treat everything — it is always to warn that Armageddon is coming.”

.. the market seems to believe it was a false deadline. Some economists have said the government would have enough cash on hand to continue making payments for several days at least. The administration could also decide how to prioritize payments. The government, for instance, could opt to pay interest on Treasuries and put off other bills.


That seems to be the view of most investors, at least judging from the direction of the Treasury bond market.

As I write this, 10-year Treasury bond yields are down below 3% again. Bonds rallying in the face of financial Armageddon? Something doesn't seem right.

As usual, one of my favorite columnists Ambrose Evans-Pritchard writing in the London Telegraph captures it best. Mr. Evans-Pritchard tells readers to "Calm down: The U.S. will not miss a coupon payment... next Wednesday". He goes on:

..nothing will in fact change when the deadline expires on August 2. The US is the world’s paramount strategic and economic power, with debts in its own sovereign currency. It can do as it pleases.

Yes, the US may be stripped of its AAA by Standard & Poor’s. A nice one-day story, but otherwise irrelevant. Global bond vigilantes are quite able to make their own judgement on the substantive default risk of the US. The rating agencies are out of their league on this one.

(By the way, the serial downgrades of Japan did not stop the yield on 10-year Japanese bonds falling to 0.5pc at one stage. What matters is whether investors really believe that they will be stiffed. In Japan they did not, and still do not.)


Still, Mr. Evans-Pritchard notes that unless the U.S. does something about the continued rise in health care costs - which is after all the major culprit in the budget deficit battle - the day will come when the world should really worry about the credit standing of the U.S.

But for now I think he's right: August 2 will come and go, and rates will largely remain at today's levels.