Shopping for Insurance Against a Debt-Ceiling Debacle? Buyer Beware
Please consider Shopping for Insurance Against a Debt-Ceiling Debacle? Buyer Beware
As of April 19, investors were willing to pay $9,600 a year to insure $1 million in U.S. Treasury debt, up from $1,400 at the start of the year. That is even more than during major budget fights in 2011 and 2013 when, like now, Republicans in Congress were refusing to raise the statutory ceiling on how much Treasury could borrow unless a Democratic president agreed to reduce spending.
“This is a direct way of observing how financial markets are trading this,” said Andy Sparks, the head of portfolio-management research at New York-based MSCI, which manages stock indexes and provides risk analysis.
Mr. Sparks said the current prices correspond to a 2% perceived probability of a default. That is low compared with, say, a corporate bond, but uncomfortably high for something that could be a financial calamity.
Odds of a Payout vs Implied Odds
The implied odds are two percent but contract trading is very thin. And some of the protection is mandatory. If regulators raise risk flags, some banks feel compelled to buy insurance.
So most likely the true odds of default are much lower.
There is also a three day grace period. We could have a default, but if it is rectified within three days, those betting on a default will be technically correct yet receive no payout.
I believe the odds of a payout on these contracts is essentially zero. But yeah, if there is a default for a couple of days, there will be “chaos” as several people on Twitter have commented.
The X-Date
Right now, everyone is scrambling to figured out the x-date. That’s the name for the date beyond which the US can no longer pay its bills, in other words, default.
Income tax receipts are running well below normal this year and that moves the x-date forward.
Tax Receipts
Calendar-Adjusted Tax Receipts
When is the X-Date?
Reuters asks When Will the US Hit its Debt Ceiling?
The U.S. government’s deadline to raise the $31.4 trillion debt ceiling could be sooner than expected, analysts have said, pulling forward the risk of a debt default that could have wide repercussions across global financial markets.
U.S. Treasury Secretary Janet Yellen said in January the government could pay its bills only through early June without increasing the limit, which the government hit in January.
Goldman Sachs analysts estimated that if April tax receipts are down by 35% or more year on year, the Treasury could announce an early June debt limit deadline. But if receipts finish down by less than 30%, a late July deadline is more likely.
“Whereas there was once a time when the Treasury Department was seen as having sufficient funding to reach August or even September … the area of focus has now been pulled forward to June, or even as early as late May,” BMO Capital Markets analysts said.
We do not have enough data yet to determine the x-date. The best guess seems to be June or July.
Whenever it is, the market does not seem to be too bothered about it right now.
Three Possible Resolutions
- Republicans Cave
- Democrats Cave
- Both Sides Give Something
Even if resolution heads into overtime there is no implied chaos. We have been into overtime before without chaos.
By overtime I do not mean default, I mean some non-essential services get shut down. For example, national parks were shut down in the last debt showdown.
Historically, Republicans have caved. Initially, I suspected they would do so again. But closer analysis has changed my mind.
Will the Debt Ceiling Cause a Fiscal Crisis or Chaos? Two Competing Views
For a look at competing views, please see Will the Debt Ceiling Cause a Fiscal Crisis or Chaos? Two Competing Views
I offered this opinion, now backed up by hard contract data “Odds of default are somewhere between 0 percent and 2 percent. Yep, that would likely mean chaos.“
We have opposite Senate-House relationships than the last two times we played these games.
I suspect votes of Senator Joe Manchin and Krysten Sinema will be instrumental in Republicans getting Biden to back down on his no-compromise stance.
This post originated at MishTalk.Com
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