Only Minor Worries in Evidence
CDS spreads on U.S. sovereign debt have recently shot up - some people likely view them as a worthwhile gamble on the off-chance that a "technical default" will occur, due to the technicalities surrounding CDS contracts. If the insurance becomes payable, the buyer of the CDS must deliver a bond that conforms to the contract specifications, and there can be worthwhile spreads between the levels at which certain bonds trade and par (which is what he gets paid, minus the premiums paid).
The writers in turn are looking at a fairly juicy premium they can pocket at the moment and they are of course betting that the government will do its utmost to avoid even a so-called "technical" default. As we have noted previously, we believe this is indeed in the government's power, since it depends mainly on spending prioritization, but we may A) have overlooked a few technicalities regarding debt maturity schedules and B) cannot predict with apodictic certainty what the political calculus will dictate and what risks may therefore be judged acceptable by the administration.
There was an interesting little note at Zerohedge on Wednesday. Apparently, Fidelity has sold all its government debt holdings that would in extremis most likely be affected by a temporary suspension of redemptions or interest payments. This is a prudent precaution from the point of view of a large financial institution like Fidelity, since it may otherwise have to explain to its clients why it didn't take the possibility into account.
Nevertheless, the 3 month T-bill discount reveals that (just as we have noted with regard to the stock market) concerns about the looming debt ceiling cut-off date are - so far anyway - a lot less pronounced than they were at a similar juncture in 2011. In short, there seems to be a certain degree of complacency discernible in this market segment too.
T-Bill Discount Rates, FF Rates and the Cause-Effect Vector
The chart is interesting for another reason as well: from a high reached early in the year and the time just prior to the recent "shutdown," the t-bill yield had declined all the way to zero.
This occurred during the time period widely predicted to contain an economic recovery. Thus the often cited magical second half recovery was certainly not reflected in t-bill yields (for more on this perennial 'the glass is always half full' theorizing, see our previous article "The Magical Second Half").
We find this fact almost more interesting than the recent increase in the t-bill discount rate on account of the debt ceiling debate (the increase is mainly interesting for being so tame).
The 3 month T-bill discount rate: the contrast between two debt ceiling confrontations and the big decline in t-bill yields from February to September are both noteworthy - via StockCharts.
We believe this actually shows how causality runs between the T-bill discount rate and the Fed's actions. It usually appears as though adjustments of the Fed Funds rate were simply the result of the Fed "following" developments in T-bill yields. This impression is created by the fact that there is usually a small lag between increases in the FF rate and increases in T-bill yields.
However, we would argue that T-bills actually reflect the market's interpretation of the Fed's communications. This is why the discount adjusts before the FF rate is moved - market participants anticipate moves in administered rates that are coming down the pike (it would probably be best to refer to a feedback loop in this context; the Fed in turn may well be influenced to some extent by the behavior of market-determined rates, at least in "normal" times).
In 2013, the steady deterioration in the FOMC's economic growth assessment has probably solidified the market's belief that the Fed really meant it when it repeatedly promised to leave rates at zilch until sometime in Quarktember 3412.