Bond ETFs Predict the Debt Ceiling Will Be Raised Without Incident

by: Gary Gordon

In the Los Angeles area, decision-makers are closing a key stretch of the 405 freeway for an entire weekend. Television hosts are calling it, “Carmageddon,” as anyone foolish enough to get in a car July 16 or July 17 may need to develop an appreciation of perpetual gridlock.

In Washington D.C., the debt ceiling debate between Democrats and Republicans offers yet another end-of-the-world scenario. Yet the stakes in this game of partisan posturing are much higher than a ruinous few days in “La La Land.” In fact, some believe that ... absent a speedy resolution ... credit markets will grind to a halt and financial assets will collapse.

Not surprisingly, I have fielded a few phone calls and/or e-mails related to the debt ceiling dilemma. I reassure clients that I protect most ETF positions with appropriate stop-limit loss orders, regardless of what causes an asset to depreciate.

Nevertheless, I have offered them an educated opinion. Specifically, the bond markets are awfully good at identifying the probability of a wide variety of outcomes. And right now, the widespread attractiveness of U.S. treasuries demonstrates a much larger fear of domestic unemployment and sovereign debt default in the eurozone.

Consider the timeline. President Obama became actively engaged in the “bipartisan” process on June 27. After bickering over Obama’s priorities during the holidays, Obama invited top Democratic and Republican lawmakers to the White House on July 5. Ongoing negotiations and public finger-pointing have continued every day since.

If the U.S. bond market smelled even the slightest “whiff” of the U.S. faltering in its debt repayment, yields would be climbing at a rapid clip. This is what has already happened to countries like Portugal, Ireland, Italy, Spain and Greece, where bond prices have tanked and yields have skyrocketed.

However, U.S. bond ETFs have hardly budged. In fact, they’ve even gained a small amount of ground, strongly hinting at the fact that the more potent worry is debt contagion in Europe.

U.S Treasury Bond Performance (6/27/11-7/12/11)
Approx %
iShares Barclays 1-3 Year Treasury (NYSEARCA:SHY) 0.0%
iShares Barclays 3-7 Year Treasury (NYSEARCA:IEI) 0.0%
iShares Barclays 7-10 Year Treasury (NYSEARCA:IEF) 0.3%
iShares Barclays 10-20 Year Treasury (NYSEARCA:TLH) 0.8%
iShares Barclays 20+ Year Treasury (NYSEARCA:TLT) 1.8%
Pimco 25+ Zero Coupon Treasury ETF (NYSEARCA:ZROZ) 3.0%