A first sign of caution

by: Georgette Boele

Investors have started to sell US Treasury bills,…

The political uncertainty stemming from the fiscal impasse has resulted in a modest rise in the US sovereign CDS spread and has prompted investors to sell short-dated US Treasuries       (1 month). This has caused liquidity to be drained out of the market and manifests itself in higher short term government bill yields. These higher yields have pushed the spread between US Libor and 1-month Treasury yield, the so-called TED spread, to very low levels. In fact, the spread has moved into negative territory (see graph). This is because the yield on a 1-month Treasury bill has risen above the 1-month US Libor, which is an exceptional situation. A negative spread reflects the market’s view that US government finances are in worse shape than US banks. In other words, this is an indication that investors are becoming concerned that the debt ceiling will not be raised on time, which could lead to a potential technical default.


… spilling over to the rest of the Treasury market,…

There are signs that investors selling US government bills is slowly spreading to other maturities in the bond market as well. Indeed, yesterday, yields in all maturity buckets in the Treasury market moved higher. Normally, higher government bond yields are a reflection of expectations of tighter monetary policy and/or higher inflation. But, in the current environment higher US government bond yields are the result of investors liquidating some positions because of the US political deadlock. What is even more interesting is that eurozone and UK government bond markets did not profit from this: prices also moved lower, driving up yields. So for the moment investors don’t seem to channel their money to other bond markets. Indeed, they seem to park their money into cash.

…but gold has received limited support so far

The performance of the ultimate safe-haven asset has been very disappointing. We would not be surprised if investors still remember gold’s behaviour during the height of the liquidity crisis back in 2008. At that time, gold was aggressively sold off, because investors favoured cash and this may still be in the back of the mind of investors


Other financial markets remain relatively calm though

However, other financial markets have remained relatively calm. Granted, equity markets have modestly moved lower, while equity market volatility has risen further, but the level of volatility has remained below the long-term average. In other words, there are no signs of panic yet. Meanwhile, currency markets have been paralysed by the US fiscal debate. In circumstances of risk aversion, the Japanese yen and the USD often outperform other currencies. But as the US is now at the epicentre of the market uncertainty, the USD has been under some pressure. Still, the Japanese yen has risen due to safe-haven flows, though these have been modest.