Treasuries show signs of distress
In good times and bad, the world’s financial system has long been able to rely on one thing: that the United States government would pay its debts on time.
This assumption has made short-term government debt the most basic building block of the financial system, as reliable as a dollar bill.
In recent days, however, the impasse in Congress has been testing investor confidence. As a result, investors have been shifting their money out of the $US1.7 trillion market for short-term US government debt known as Treasury bills, worried, for the moment at least, that they may not be the risk-free asset they have known.
‘‘These bills are like the centre of gravity for the financial universe,’’ said Lee Sachs, a former Treasury official who now runs lending firm Alliance Partners. ‘‘Defaulting on these would be like the laws of physics being repealed.’’
Many investors are not reading much into the recent changes in the Treasury bill market, given that it is one narrow corner of the financial world. More visible markets, such as stocks, are still showing relatively little concern about a default.
But traders and bankers are watching movements in the price of Treasury bills because they could show the first tremors of an earthquake if Congress fails to raise the government’s borrowing limit. Treasury Secretary Jacob Lew has said that after October 17 the Treasury will no longer be able to borrow money and may not be able to pay its bills.
No one is questioning yet whether the government will, at some point, pay back all the money it has borrowed. But investors are entertaining doubts about whether Washington will pay back money on the date it has promised, a fundamental expectation that helps lubricate day-to-day transactions in the financial system.
‘‘That is a very big change in perception,’’ said Cutwater Asset Management chief executive Clifford Corso. ‘‘Much of the world relies on that certainty of date of payment. That chain is a very large and dangerous one to monkey with.’’
The clearest sign of the changing perceptions has come in the prices for the bills that the Treasury Department is supposed to repay in the days after the debt ceiling is reached.
Normally, as the day of repayment for a Treasury bill gets closer, the chances of being repaid go up and the bill becomes worth more to investors. Now, the opposite is happening, and the bills are losing value, making them available at a discount to their face value.
The discount on bills to be paid on October 24 has grown by 400 per cent since the beginning of the month. That has brought the price that the government has to pay to borrow money for a month to three times what the average AA-rated American company has to pay, according to Federal Reserve data. Typically, the US government can borrow more cheaply than big corporations.
Confidence in investments considered to have little or no risk has been periodically shattered in the recent past. Until 2008, most investors believed they could not lose money on mortgage-backed bonds that carried a rating of AAA. Last year, investors were forced to rethink their belief that countries in the European Union would always repay their debt.
The trust in debt issued by the US, however, has always run deeper because of the size of the economy and the presumed ability of the government to print as much money as it needs. This has meant that during the past two big crises, most investors sought Treasury debt as a haven.
So far, despite mounting worries over the standoff in Washington, investors have not been turning away from Treasury debt altogether. They have largely remained confident that the government will pay back its longer-term debt on time, keeping the prices of those bonds stable.
But any debt set to come due in late October or November has become much less popular. And the concern has been stretching further into the future.