Debt Markets React to Washington – Finally


People have noted the failure to demand higher yields for treasuries, and concluded that the debt markets don’t believe there’s any problem with August 2, or 10, or any other date we care to mention.  In fact, this was largely out of disbelief that Washington could fail to act.

In fact, this week, the debt markets have begun to react.  Banks are beginning to pull money out of treasury-heavy money market funds, which in turn are selling treasuries and putting their money in banks.  This has the effect of reducing the financial flexibility of each.  The repo market – where financial institutions lend securities money to one another, using treasuries as collateral – is beginning to demand higher interest rates.  Companies that don’t even like debt are issuing short-term commercial paper to make sure they have cash on hand.  Let’s not turn this into panic – it’s not.  But the markets are beginning to take prudent and overdue steps to protect themselves against a loss of liquidity in treasuries, even if it doesn’t mean technical default.

In the meantime, it appears that Speaker Boehner has agreed to a stricter Balanced Budget Amendment requirement for the 2nd round of cuts & debt limit increases – requiring passage rather than just a vote.  I think this is a mistake.

There is every indication that Boehner Plan 2.0 was pretty close to the plan that he and Harry Reid presented to the President on Sunday, and which he indicated he would veto.  But a close reading of the tea leaves also indicates that he was hoping that a strong enough statement against it would prevent him from actually having to make that decision.  If he had signed it, it would have strengthened the conservative case for governance immensely.

Now, the House has probably made it more likely that they will end up voting on – and probably passing – some compromise between McConnell and Reid.  That deal would, in fact, work towards marginalizing the Tea Party groups who have done so much to get us to this point.

I hope I’m wrong, and that the wording of the BBA is something that can get passed – it requires no presidential signature – and that the extra time we’re buying is put to good use making the case for it.  Certainly Obama & the Democrats’ desire to run the federal budget on auto-pilot helps in that regard.

But if not, and if the 30 or so Republicans end up setting the stage for an exact repeat of this in 6 months, with no BBA in hand, they may well end up moving the debate to the left, rather than to the right.

One other point – I do think reasoned analyses such as McArdle’s, which show what will likely happen if we don’t raise the ceiling, without the histrionics, actually help our case down the road.  If the markets do shudder a little bit, it should server as a spectre of what will actually happen, for real, when the debt markets finally decide to take that decision out of Washington’s hands altogether.

UPDATE: The Dollar-denominated Swiss Franc ETF, FXF, opened almost 2% higher this morning, and stayed there the whole day.  I went back and looked, and since 2006, the daily percentage change has been bigger than this – in this direction – only 10 days, so this is definitely a multi-sigma event.  One guess as to why it happened.

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