What to observe for market stress because the U.S. debt ceiling deadline nears

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NEW YORK, Oct 5 (Reuters) – Worries in regards to the debt ceiling are starting to rattle traders because the deadline nears for Congress to boost the U.S. borrowing restrict to keep away from a historic default on U.S. debt.

With two weeks earlier than the Oct. 18 deadline, President Joe Biden mentioned Monday he can’t assure the federal government won’t breach its $28.4 trillion debt restrict except Republicans be a part of Democrats in voting to boost it. learn extra

Concerns are mounting out there for short-term payments, credit score default spreads on U.S. debt and generally market sentiment. U.S. Treasury Secretary Janet Yellen has mentioned the federal government will run out of money round that date except Congress raises the restrict on the federal debt.

“The debt ceiling and infrastructure talks out of (Washington), D.C., will continue to be front and center this week amid more hints that ratings agencies could take the U.S. credit rating down a notch if the drama continues,” mentioned Arthur Hogan, chief market strategist at National Securities Corp.

SHORT-TERM TREASURY SPREADS

There are indicators of stress within the Treasury invoice market, with 1-month payments that may be affected by a possible default yielding larger than 3-month payments.

One-month payments at the moment yield 0.1%, near their highest ranges since March on an intraday foundation, in contrast with a 0.038% yield in three-month payments . The unfold between one-month and three-month payments is the widest since March 2020.

Portfolio managers usually keep away from invoice points liable to default even when the chance of a failed fee may be very low. This can ship yields on some points larger than these on longer-dated debt, an uncommon incidence within the yield curve, which is usually upward-sloping. learn extra

Reuters Graphics
Reuters Graphics

U.S. REPO MARKET

Except for some minor volatility, the U.S. in a single day repurchase settlement (repo) market has proven little indicators of stress.

Overnight repo charges on Monday closed at 0.05% . There had been some pockets of volatility, merchants mentioned, in the previous few days. Last week, in a single day repo charges traded as excessive as 0.07%, however fell as little as -0.10%.

As the debt ceiling deadline looms, repo charges have turn out to be risky as a result of with the U.S. Treasury anticipated to run down its money steadiness, the surplus funds circulation into the banking system as reserves. Banks can both select to put money into the repo market, which pushes charges decrease, or lend to the Federal Reserve through its reverse repo facility. That takes cash away from the repo market and tends to raise in a single day charges just a little larger.

“Except for perhaps some elevated volatility, I don’t see anything outsized at this point that makes me think it’s resulting from increased angst about the debt ceiling,” mentioned Dan Belton, fixed-income strategist, at BMO Capital in Chicago.

Rates within the repo market are additionally affected at sure dates of the month by inflows from authorities state enterprises equivalent to Fannie Mae and Freddie Mac.

Last Thursday, quantity on the Fed’s reverse repo window soared to a document $1.604 trillion, as traders flocked to the U.S. central financial institution facility the place they’re paid a assured 5 foundation for in a single day money with out counterparty danger.

Steady repo market
Steady repo market

OPTIONS MARKET

When traders are anxious about an upcoming occasion, they usually load up on choices hedges, thereby driving up volatility embedded in these choices.

Options on S&P 500 (.SPX) and its monitoring ETF (SPY.P), expiring on Oct. 15, simply previous to the debt ceiling deadline, show just a bit bit further volatility priced into them in comparison with contracts expiring earlier than and after.

A extra important rise in volatility for expirations on and across the Oct. 18 deadline in coming days would inform that the debt ceiling showdown is garnering extra consideration from traders.

Reuters Graphics
Reuters Graphics

CREDIT DEFAULT SWAPS

Thinly traded credit score default swaps that may repay within the case of a U.S. authorities default have spiked in current days, although they continue to be far under the place they traded in the course of the summer time of 2011 when extended debt ceiling negotiations led to rankings companies downgrading U.S. debt, in line with Moody’s analytics.

One-year credit-default swaps at the moment are buying and selling at ranges final seen in December 2020, in line with Refinitiv information, by means of stay roughly 40% decrease than they had been in March 2020 when a lot of the U.S. economic system shutdown in the course of the early levels of the coronavirus pandemic.

CDS
CDS

MONEY MARKET FLOWS

In one signal of rising nervousness, traders despatched roughly $33 billion into money-market funds the week that ended Sept. 29. That transfer to money pushed the whole property of the $3.9 trillion cash market trade to its highest ranges since June, in line with information from the Investment Company Institute.

Reuters Graphics
Reuters Graphics
Reporting by David Randall, Saqib Iqbal Ahmed and Gertrude Chavez-Dreyfuss; Additional reporting by Stephen Culp; Editing by Megan Davies and Lisa Shumaker

A U.S. five dollar note is seen in this illustration photo June 1, 2017.     REUTERS/Thomas White/Illustration

Reuters Graphics

Steady repo market

Reuters Graphics

CDS

Reuters Graphics