Financial Markets Seem Disinterested In Debt Discord

Jul 11, 2011
Originally published on July 11, 2011 1:49 pm

Washington may be preoccupied with the debate over whether to raise the debt ceiling and the consequences of a default, but so far at least, the nation's financial markets appear to be taking the prospect in stride.

Although politicians from President Obama on down have been predicting for weeks that a debt default would wreak havoc on the global economy, interest rates on U.S. government debt remain near historic lows.

The 10-year Treasury bill, often seen as a barometer of investor sentiment toward the bond market, hovered around 3 percent Friday.

An Economic Disaster

Most economists believe that a failure to raise the debt ceiling would be a catastrophe for the global economy, particularly if it drags on. The federal government would no longer have the money to pay its bills, and would be forced to choose between writing checks for expenditures like Social Security and making good on its obligations to bondholders.

The mere prospect that the U.S. might default on its debts would scare investors and force them to look for alternative places to stash their money, says John Canavan, who analyzes the bond markets for Stone and McCarthy.

"A lot of money that would typically flow into Treasuries in times of uncertainty would be more likely to flow into Bunds in particular — that is, German debt markets," he says.

With money no longer flowing into the Treasury markets, the U.S. government would have to pay more to borrow what it needs, driving up interest rates for mortgages, business loans and other kinds of credit.

Investors Stay Put

The fact that nothing like that has happened so far means investors are sticking with U.S. Treasury debt. That suggests that many investors believe the debt-ceiling debate will be resolved before Aug. 2, when the federal government is expected to run out of money.

Jim Paulsen, chief investment strategist at Wells Capital Management, sees the controversy as little more than political theatrics, and says it's virtually certain that the White House and members of Congress will end the impasse before it's too late.

"The reality is not a one of them is going to allow an effective and meaningful default by the U.S. government," Paulsen says.

"Right now it seems like the markets, as well as myself, believe that the government is going to come to its senses and come up with some plan at the last minute," says Beth Ann Bovino, senior economist at Standard and Poor's.

"Certainly, politicians like to [show] bravado, so it's probably going to happen at the last minute, just like a Hollywood blockbuster," she adds.

Other, Bigger Worries

But there may be another reason interest rates remain so low.

Simply put, the financial markets have a lot on their plates right now. The European debt crisis, the surge in energy prices and the continued weakness in the employment market are all threatening economic growth.

"There has been some indication of a little bit of nervousness but as far as the treasury markets are concerned, there have been more pressing, near-term concerns," Canavan says.

These troubles are forcing investors to look for other places to stash their money. For all the problems facing the domestic economy right now, the Treasury markets are still seen as among the safest and most liquid in the world, Bovino says.

The QE2 Sets Sail

Not even the end of the Federal Reserve's so-called QE2 program has ruffled the markets.

Under the program, the Fed purchased $600 billion in long-term Treasury bills as a way of pouring money into the economy and bringing down interest rates.

When Fed officials announced they would let the program expire on June 30, there were predictions that it would push rates back up.

But investors seemed largely unfazed by the move.

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As we heard earlier in the program, the debate over whether to raise the nation's debt ceiling has absorbed Washington lately. And President Obama will be holding a press conference on the issue later this morning. There are warnings that economic disaster could ensue if Congress fails to act. But as NPR's Jim Zarroli reports, the nation's financial markets seem to be taking the debate in stride.

JIM ZARROLI: It's not hard to find economists who think that it would be a big disaster for the U.S. economy if Congress doesn't raise the debt ceiling. All of a sudden the government wouldn't have enough money to pay its debts, so it would have to stop writing checks for things like Social Security or stop paying back the debt it owes or maybe both.

Beth Ann Bovino is an economist with Standard and Poor's.

Ms. BETH ANN BOVINO (Senior Economist, Standard and Poor's): I think the government is playing with fire.

ZARROLI: And yet if the economy is approaching Armageddon somebody forgot to tell the financial markets. Take Treasury bills. If investors were worried about a default they would flee U.S. government debt and look for other places to put their money.

John Canavan analyses the credit markets at Stone and McCarthy.

Mr. JOHN CANAVAN (Market Analyst, Stone and McCarthy): A lot of money that would typically flow into treasuries in times of uncertainty would be more likely to flow into perhaps bunds in particular. That is, German debt markets.

ZARROLI: And with less money flowing into treasuries, the government would have to pay higher interest rates to borrow what it needs. Mortgage rates would go up and businesses would have to pay more to borrow.

But nothing like that is happening yet. In fact, interest rates are still near historic lows. The yield on the 10-year Treasury bill hovered near 3 percent on Friday.

Why are investors being so blase? John Canavan says they're simply focused on other things right now.

Mr. CANAVAN: There has been some indication of a little bit of nervousness. But as far as the treasury market is concerned, there've been more pressing, near-term concerns.

ZARROLI: Canavan says investors are concentrating on the slowing U.S. economy and the European debt crisis. As a result, Beth Ann Bovino says investors are looking for safe havens to put their money. And for all their problems right now, the U.S. treasury markets still seem like the safest and most liquid in the world.

Ms. BOVINO: We're seeing weakness and certainly risk in the rest of the world, particularly in the Eurozone. So money is moving out of the rest of the world and into U.S. government debt.

ZARROLI: The fact that money keep flowing into U.S. government debt also suggests that many investors aren't yet taking the crisis seriously.

Jim Paulsen of Wells Capital Management is one of many people in the markets who think the current debt ceiling debate is little more than political theater. Members of Congress, he says, will almost certainly resolve the issue, because the consequences of not doing so would be too terrible.

Mr. JIM PAULSEN (Chief Investment Strategist, Wells Capital Management): The reality is not a one of them is going to allow an effective and meaningful default of the U.S. government.

ZARROLI: Paulsen says far more important to investors right now are things like unemployment and retail sales data.

Mr. PAULSEN: Those are what's going to drive these markets for the rest of the year, not this politically made up drama.

ZARROLI: And investors all over the world basically know this, he says. So with all of the other things going on in the economy they still see the U.S. treasury markets as safe. That could change as the deadline approaches, but for now investors have other things on their minds.

KELLY: This is NPR News. Transcript provided by NPR, Copyright NPR.