This is a theme repeated in the markets: Really bad events are ignored until they are so close that they demand immediate attention.
Investors clearly expected Republicans to cave, with short-term Treasury bill prices showing that even if a default did occur, any problems would be short-lived. However, markets are terrible at assessing high-impact events that are very unlikely to happen. This can cause sudden drastic changes in prices. The result is a form of enduring complacency, where impossible but really bad events are ignored until they are so close that they demand immediate attention.
This month the price of Treasury bills started falling on the threat that there would be a temporary problem. The yield on T-bills due to mature on October 26, shortly after the most likely breach of the loan limit, rose from 0.05% at the beginning of the month to 0.15% as of Tuesday. It fell to 0.08% after Senate Minority Leader Mitch McConnell offered a two-month suspension of the debt limit. The government was paying more for some of the short-term borrowings from higher-rated companies.
As officials spoke out disaster scenarios in an effort to bring on Senate Republicans, Treasury Secretary Janet Yellen said a default “is likely to be a historic financial crisis.”
Investors never thought a problem would persist. Yields on bills maturing in December had fallen rather than increased. Just as Republicans threatened to take the country to the brink in 2011, the best place to hide from the US default was… the Treasury. American assets are absolutely central to the global financial system, and no one believes that senators will put it at risk for more than a few days.
Worse, if the US defaulted entirely, and remained in default, and the Federal Reserve did nothing about it, it would wipe out the value of almost everything. Companies, banks, other governments and individuals will default, and the world economy will be crushed. It is not clear whether any assets will provide shelter to the lack of well-stocked bunkers.
It was perfectly reasonable for investors to think that such a default almost certainly would not happen. The last time Republicans decided that debt limits mattered during the Obama administration, they threatened default twice before backtracking. In 2011 the markets took it badly and the US lost its old credit rating. By 2013, investors had decided that the politicians were all sly, and largely ignored the threats that year.
On top of that, there are a number of ways the government can avoid or reduce defaults, including eliminating filibuster, claiming Congress violates the Constitution, coining the $1 trillion or asking the Fed to buy defaulted bills and bonds. to persuade.
It’s also fair to think that a minor omission doesn’t matter much. America has fail to meet its obligations At least three times in her history, contrary to Ms Yellen’s claim that she has always paid her bills on time.
These repeated failures to pay—after the War of 1812, an “embarrassing back office crunch” on gold given to Panama in 1933 and what the Wall Street Journal reported at the time in 1979—were America’s ability did not interfere. To borrow more, or obviously inflate costs. This is not surprising when you look at the ability of even the most dangerous emerging market governments to take on new loans immediately after defaulting. Investors focus on the future and think that even for serial defaulters such as Argentina or Greece, each default is outright.
Which leaves us with the question of whether the market was satisfied this time around, and therefore may still be complacent about a default in December, especially one that lasts more than a few days. History is replete with examples of catastrophic defaults, although cases where countries completely forgo their debt usually come after a revolution, not a partisan standoff.
The biggest example of market complacency in the past few decades was just last year, when investors ignored the spread of COVID-19 for weeks after human-to-human transmission was confirmed. The crash started only after Italy locked down parts of the country. Complacency can also apply to events that have been widely predicted, such as the now-probable default by the China Evergrande Group.handjob
Or the bursting of the dot-com bubble. Bad things will probably happen one day, cause many investors, but I’m smart enough to run out of time. Of course, not everyone can get out at once.
In all these past cases, policy makers and the wider population were as satisfied as the markets. If something is too dire to think about, during good times only the deepest recession will want to consider it.
It’s both hope and fear about the American lapse: It’s too terrible for Republicans to consider or allow the White House. It’s also so terrifying that investors haven’t prepared, widening the market’s influence should, in the end, come to pass.
Write to James Mackintosh at [email protected]