Traders and investors are getting more nervous as the government shut down continues with no signs of progress and the October 17 deadline for raising the debt ceiling approaches.
The price of credit-default swaps (CDS) used to insure U.S. government debt against the possibility of default climbed to 35.5 basis points yesterday. That was the highest level in six months, and up from 32 basis points on Friday, September 27. But that level is still well below the 62 basis points it cost to insure U.S. government debt against default at the time of last debt ceiling battle in the summer of 2011. That was the highest level since the global financial crisis. (What this means is that an investor would pay 62,000 euros a year to insure 10 million euros of U.S. Treasuries against a default in the next five years. The contract is denominated in euros to offset the impact of a default on the U.S. dollar.) This insurance is getting more popular too with these CDS contracts ranking as the 15th most traded of the contracts tracked by the Depository Trust & Clearing Corp. in the week through Sept. 27. That’s up from a rank of 147th for the previous week.
Investors and traders are also starting to shy away from those Treasury bills maturing closest to the October 17 deadline projected by the U.S. Treasury.The difference in yields between the one and three-month Treasury bills now makes up the biggest gap since the 2008 financial crisis. One-month yields have climbed to 0.13% but three-month bills pay just 0.02%. Financial institutions frequently use short Treasury bills for collateral and nobody wants to get caught short on collateral in case of a default.
All this said, while markets are more nervous, they aren’t exactly very nervous yet—as the price of CDS indicates. News stories today out of Washington have House Speaker John Boehner saying that he will use a coalition of Democrats and Republicans to pass a debt ceiling extension to avoid default. The speaker’s staff has denied these accounts. And Wall Street analysts who have dug into the details of the government’s cash flow say that Treasury won’t actually run out of the ability to pay the government’s debts until the big bills due on November 1. (Aren’t you relieved?)
It will be interesting—a nice neutral word—to see how traders feel tomorrow about the risk represented by a weekend with big news potential but no trading opportunities.