Global Economy Will Keep Faith in U.S. Bonds

U.S. will preserve Treasury bond value even if priority payments needed.

A pedestrian walks past the U.S. Treasury Building on Thursday, Oct. 10, 2013, in Washington, D.C.
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A deal to resume government funding seems elusive on Wednesday, a day before the U.S. Treasury will reportedly begin running on emergency cash, but default or no default, U.S. bonds will likely remain the preferred safe investment for the global economy.

U.S. Treasury bonds are the most popular reserve security in the world, so financial transactions worldwide could be damaged and the savings of numerous countries endangered if the U.S. could no longer be counted on to pay its bills as money starts to run out sometime after Oct. 17. Domestically a default would increase interest rates in numerous sectors including mortgages, credit cards and auto loans.

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Foreign officials are unlikely to shift their funds away from U.S. Treasury bonds and any damage to the global economy will be short-lived, assuming there is a benign resolution to the fiscal standoff and a default on the debt is averted, says Joseph Lupton, a global economist at JPMorgan Chase investment firm.

Central banks of nations in emerging markets regions including Asia continued to buy Treasury bonds as a reserve investment although Standard & Poor’s downgraded the credit rating of the U.S. from AAA to AA the last time the U.S. came close to a default on its debt in 2011, Lupton explains.

 

“In 2011 there was more of a wakeup call to how dysfunctional politics has gotten in the U.S., and it prompted a downgrade,” Lupton says, “You still had a world in which U.S. assets were viewed as a safe haven.” Treasury bonds have good prospects in the year ahead because there has been stabilization in the private sector, but also because “there are not a lot of good alternatives,” Lupton says.

“Europe is improving but there are still some concerns there with the Euro,” Lupton explains.

The U.S. debt crisis and the stalemate in Congress is embarrassing, but financial markets have learned from the close call to a default that occurred in 2011, so permanent damage to the global economy is unlikely, Lupton says.

“Markets have grown somewhat used to the idea of governance by crisis in the U.S., and there is a sense that this is going to be resolved somehow,” Lupton says.

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However there are ill tidings during the immediate future for central banks searching for a safe haven to stash reserves as the U.S. government shutdown drags into its 16th day on Wednesday. Money management firms including JPMorgan Chase and Fidelity Investments have sold short-term U.S. government bonds as a precaution in case the Treasury cannot pay bills owed between late October and early November. This sell-off continued on Tuesday as the yield on a four-month Treasury bill that matures on Oct. 24 climbed to 0.5 percent, USA Today reports.

Fitch Research analysts also warned that the firm is considering downgrading the rating of U.S. government debt from AAA as a precaution on Tuesday, while the firm expects to resolve that negative outlook in the first quarter of 2014.

“Although Fitch continues to believe that the debt ceiling will be raised soon, the political brinkmanship and reduced financing flexibility could increase the risk of a U.S. default,” the firm explained in a report on Tuesday.

The Treasury will likely not allow a default on the government debt, even if it decides to prioritize debt repayments in the event that the debt ceiling is reached, says Jacob Kirkegaard, senior fellow at the Peterson Institute for International Economics. That would protect the world bond economy, but could drive the U.S. economy into a recession because of the massive spending cuts that would result, Kirkegaard says.

“The administration could have to prioritize debt and interest payments by cutting Social Security and other entitlement programs,” Kirkegaard says. “Saving the bond market economy is going to come at the expense of the real economy. Ironically the bond market is politically quite safe.”

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