Sovereign Debt

But I never thought it wise to sell it, because for central banks this is a reserve of safety, it’s viewed by the country as such. In the case of non-dollar countries it gives you a value-protection against fluctuations against the dollar, so there are several reasons, risk diversification and so on.

The world’s developed countries face growth and employment shortfalls, while developing countries are confronting huge challenges in adapting to increasingly volatile capital flows while adjusting their growth patterns to sustain economic development. And yet America’s political dysfunction has come to marginalize these (and other) crucial issues. It is all very difficult to fathom. The threat of a default on US sovereign debt has been lifted – for now – but the deeper problem persists: For America’s Republicans and Democrats, negotiating a fiscal grand compromise appears to carry higher costs than playing a game of brinkmanship, even at the risk of default. Surely this involves a collective miscalculation of the longer-term costs.

Some confidence tricks have characteristics that don’t quite fit the Fonz. Take the swindles known as Ponzi schemes. These are tricks that need an endless supply of participants to sustain confidence and stay alive. Once the participant pool depletes as it eventually must, the tricks are revealed as scams. Whereas Fonzies can persist indefinitely (at least in theory), Ponzis eventually collapse. Note that the U.S. has already passed its Ponzi point by Minsky’s definition. According to Minsky, borrowing qualifies as Ponzi finance whenever fresh issuance is needed to fund interest on existing debt.  Based on the common assumption that the U.S. would miss its interest payments without regular increases in the statutory debt limit, this is indeed the case

Since all US rating agencies (Fitch is majority French-owned) have been terrified into submission and will never again touch the rating of the US following the DOJ's witch hunt of S&P, any US rating changes on the margin will come from abroad. Like China's Dagong rating agency, which several hours ago just downgraded the US from A to A-, maintaining its negative outlook. The agency said that while a default has been averted by a last minute agreement in Congress, the fundamental situation of debt growth outpacing fiscal income and GDP remains unchanged. "Hence the government is still approaching the verge of default crisis, a situation that cannot be substantially alleviated in the foreseeable future."

As markets twiddle their thumbs waiting on Washington to come up with a political solution to the Federal Debt Limit/budget debate, ConvergEx's Nick Colas decided it would be a good time to review the academic literature on how markets discount expectations in the first place. Behavioral finance posits that human nature skews perceptions of risk and return, causing everything from irrational risk aversion to asset price bubbles. Against this current backdrop of theoretical uncertainty, measures like the VIX are currently somnambulant.  So, using the modern vernacular, WTF?  The bottom line, Colas explains, is that Wall Street thinks it has the current "Crisis" all figured out: a last minute deal with no Treasury default.  And just as we haven’t sold off materially during this drama, don’t expect a huge (+5%) lift afterwards.

So what exactly did Reid know and when?

• *UNITED STATES' AAA IDR RATING MAY BE CUT BY FITCH :3352Z US
• FITCH SAYS PUTS U.S. ON RATING WATCH NEGATIVE AS U.S. AUTHORITIES HAVE NOT RAISED FEDERAL DEBT CEILING IN A "TIMELY MANNER
• *FITCH STILL SEES U.S. DEBT CEILING TO BE RAISED SOON :3352Z US
• *FITCH SEES RESOLVING US RWN BY END OF 1Q '14 AT LATEST
• *FITCH STILL SEES U.S. DEBT CEILING TO BE RAISED SOON :3352Z US
• *FITCH SEES U.S. ECONOMIC GROWTH REVERTING TO 2.25% AFTER 2017

If one looks at various sovereign states, it seemingly doesn't matter that their public debts continue to rise at a hefty clip. The largest ones are considered to have economies that are big and resilient enough to be able to support the growing debt load. Part of the calculus is no doubt the notion that they contain enough accumulated wealth to allow their governments to confiscate even more of their citizens property and income in order to make good on their debts. Then there are the small and mid-sized states in the EU that are getting bailed out by their larger brethren, or rather, the tax payers of their larger brethren. However, things are different when the territories or municipalities concerned are considered too small and have no such back-up. Detroit was a recent case in point, and it seems that the US territory of Puerto Rico is the next domino to fall.

Two bailouts, a default and a half later, it should be obvious that Greece was stripped of its sovereignty for nothing. Should I say "I told you so"???

The cost of protecting against a default on US Treasuries for one-year has surged to 60bps this morning. This is the highest since the Debt-ceiling debacle in 2011 and worse than Lehman. The 1Y cost is the highest relative to the 5Y cost ever. However, many people look at the 60bps and shrug it off as de minimus, after-all, JCPenney trades at 1200bps and is still alive. This is a mistake. The price of protection for US sovereign debt depends on recovery expectations and the EURUSD exchange rate expectations. Based on current levels, USA CDS imply a 5.9% probability of default - the same as JCPenney in July.

The BPC, whose initial analysis of the US default has become the staple "go-to" analysis for Treasury cash obligations and key events in the day surrounding and following the X-Date, has released a new update on when the US runs out of money. The latest: October 22 - November 1. Which means that if it so desires, the GOP can and probably will delay a debt ceiling bargain until the last possible moment which may well be, appropriately enough, Halloween. In the meantime, the US Treasury now has about $40 billion in total cash on hand and available extraordinary measures and declining fast.

During the European crisis, we saw sovereign debt yields rising way above their domestic banking sector's yields as investors feared systemic crisis and technical flows dominated the price action amid aggressive hedging. Now, with Washington looking increasingly likely to crash upon the shores of a US Treasury technical default, for the first time on record the yield on short-term Treasury-Bills is above the yield on US interbank loans. T-Bill yields (the US government's "risk") have surpassed short-term LIBOR (US Banks' "Risk")... must be a good reason to BTFATH...

With short-term Treasury Bills starting to price in a missed payment possibility and USA CDS surging (though still low), the debt ceiling (and implicit chance of a technical default) is nigh. As we approach yet another debt ceiling showdown (especially in light of the seeming congruence of a CR and debt ceiling debate in an entirely divided Washington), market attention will turn towards a possible US sovereign rating downgrade. In this article, we provide an outline of the likely actions by the three rating agencies (S&P, Moody’s and Fitch).

• U.S. Government Shut Down With No Quick Resolution Seen (BBG)
• 12 House Republicans now say they’d back a ‘clean’ CR (WaPo)
• Republicans’ 2014 Senate Edge Muddied by Shutdown Message (BBG)
• Obama Shortens Asia Trip Due to Government Shutdown (WSJ)
• Fed Said to Review Commodities at Goldman, Morgan Stanley (BBG)
• Foreign Firms Tap U.S. Gas Bonanza (WSJ)
• Behind Standoff, a Broken Process in Need of a Broker (WSJ)
• Japan Awaits Abe’s Third Arrow as Companies Urged to Invest (BBG)
• Microsoft investors push for chairman Gates to step down (Reuters)

With enough real and electronic ink spilled over the past two weeks to describe every nuance of the Lehman crisis (as if anyone can ever forget those vivid days) that nearly 3 months worth of Treasury issuance could be monetized, we decided to go further back, some 140 years back in fact, to this day in 1873 which just happens to be day the first Great market Panic gripped the US, and resulted in the first ever shutdown of the New York Stock Exchange. Granted, these days the NYSE or N-ICE as it is currently known, and the NASDARK shut down on a daily basis courtesy of a billion collocated vacuum tubes and the rigged casino formerly known as the stock market, on a virtually daily basis. But back then, when the general population was still largely clueless just how broken and corrupt the ideal of market efficiency would become when commingled with political and corporate interests, it was quite a shock.

The equity market’s reactions to monetary policy inflection points, when (or if) the Fed takes the first step to normalize monetary policy following easing in response to recession, have been reasonably similar. As Barclays' Barry Knapp notes, irrespective of the pace of policy accommodation removal – the average policy normalization-related correction during the prior six business cycles is 8.9%. While our memories of an extremely volatile September – five years ago – remain fresh, the last four have been exceptionally tame. However, while another period of fiscal uncertainty seems likely, Knapp fears there is a key difference between this September and the surprisingly low volatility Septembers in 2009-12. In those periods, the Fed was either buying assets or had pre-announced a new program; this year, it is preparing to weaken the portfolio balance effect.