NEW YORK -- The first alarm bells are starting to go off on Wall Street as brinkmanship over raising the U.S. government's $31.4 trillion debt limit raises worries in financial markets.
The stakes are immense. Democrats and Republicans are arguing over whether to raise the cap that's been set for the U.S. government's borrowing. It's a debate that's happened many times before, each time ending with a default-defying increase.
Failure to find a fix would spell disaster for many, not least holders of U.S. debt who wouldn't get promised payments on time. Economists widely expect a recession to follow and potential chaos in markets. U.S. Treasurys are the foundation of financial markets around the world, on top of which all kinds of other investments set their prices, from stocks to foreign currencies.
While U.S. stocks have remained mostly calm through the latest debt-ceiling drama, volatility strategists at Barclays Capital point to another corner of the market where fear is popping up: short-term Treasury yields.
A Treasury maturing in one month yielded 3.68% Tuesday, for example. But for investors willing to wait just two months more, a three-month Treasury yielded a much fatter 5.03%.
That gap between the one-month and three-month Treasury yields has gotten close to 1.80 percentage points recently as investors herd into one-month Treasurys, which look likely to mature before any mayhem occurs.
For context, the gap between one- and three-month Treasurys was typically under 0.03 percentage points over the last decade.
The moves may be exacerbated by a flood of cash looking for new homes recently. Households and companies yanked deposits out of banks last month when fears rose following two of the largest U.S. bank failures in history. Much of that cash ended up in short-term Treasurys.
Nervousness is rising as the so-called “X-date” that investors expect the U.S. to potentially default creeps forward. Some are talking about the possibility of hitting the date by early June.
Isaac Boltansky, director of policy research at BTIG, said he's seen a marked increase in questions from clients about the debt ceiling, but “the conventional wisdom among both clients and contacts is that there will be a resolution before the unthinkable becomes reality.”
The X-date is coming no matter what happens because the U.S. government needs to pay off what it’s borrowed already, regardless of how much it spends in the future. Most economists also say the U.S. is on an unsustainable path and will need to make big changes when it comes to debt.
“The debt ceiling battle has two components that may impact investors: the battle itself, which is political, and the underlying economic issue of debt sustainability," said Lauren Goodwin, economist and portfolio strategist at New York Life Investments. "There are real costs to brinkmanship, even if an outright disaster is avoided.”
