You’d hardly know by looking at financial markets that the US debt limit was breached in January. But that’s starting to change, in what is shaping up to be a nail-biting game of debt ceiling squabbling as the shot clock is winding down.
If lawmakers don’t raise the nation’s borrowing limit by June, the federal government runs the risk of defaulting on its debt obligations, Treasury Secretary Janet Yellen said in January. That would be catastrophic for the economy and put millions of jobs in jeopardy, Moody’s chief economist said.
Markets aren’t shrugging that off.
Investors are demanding historically high yields for US Treasury notes that mature in July, which by some estimates is when the United States will default on its debt, absent any legislative action. That would mean bondholders aren’t repaid the money they’re owed on time.
Yields for three-month Treasury notes closed at 5.1% Thursday. That exceeded yields for longer-term Treasury notes.
Bonds with longer maturity dates tend to pay higher interest rates to compensate investors for locking down their money for a greater period of time. There’s also more uncertainty around the path that interest rates will take during that time.
When yields on shorter-term bonds exceed those of longer-term bonds it’s often a sign that bad economic times are ahead.
Investors’ anxieties are also evident in spreads on US five-year credit default swaps, which have widened to 50 basis points, according to S&P Global Market Intelligence data. When the debt ceiling was breached in January, five-year CDS spreads hovered around 35 basis points.
When a bondholder purchases a credit default swap they are guaranteed to receive the money they’re owed in the event that the bond issuer defaults. But when the chances of a default rise, it becomes more expensive to buy a credit default swap — leading their spreads to widen.
How does this compare to the 2011 debt ceiling debacle?
In 2011 a debt ceiling standoff led to credit-rating agency Standard and Poor’s downgrade of US debt from the highest possible status, AAA, to AA+.
After that occurred, the cost of insuring against US debt for a year jumped to 63 basis points. That’s well below the current cost ,which recently rose above 100 basis points, according to Refinitiv data.
Short-term bonds offered significantly lower yields in 2011. Yields on three-month Treasury notes peaked at around 1.1% right before lawmakers reached an agreement to raise the debt ceiling in August. Yields for longer-term bonds exceeded shorter-term bonds during the negotiations, unlike what is currently happening.
But US markets are weighing in on more than just the prospect of the United States defaulting on its debt. The banking sector, though stable, remains on edge after recent bank failures. Inflation has yet to come close to the Federal Reserve’s 2% target, prompting the Fed to continue to hike interest rates — which economists fear will push the economy into a recession.
