Hopes of a short-term solution

by: Peter de Bruin , Georgette Boele

Hopes of short-time debt ceiling solution…

Yesterday, House Republicans considered offering the White House a six week debt ceiling extension in exchange for negotiations on longer-term budget issues with Democrats. The plan, which would not include any additional policy demands, would suspend the debt ceiling limit to 22 November. Interestingly, it would not allow the Treasury to use extraordinary measures to lift the nation’s borrowing capacity beyond this date. As such,  in contrast to the ‘soft’ deadline of the 17th of October that the Treasury currently has imposed, it would create a ‘hard’ deadline, setting the stage for what could be tough negotiations. Indeed, the Republicans’ plan, which most likely will be brought to vote in the House on Friday, would not allow the government to be reopened. For that to happen, Democrats first would need to give in to Republicans’ demands. All in all, it is positive to see that Republicans want to extend the debt ceiling deadline. Indeed, although President Obama has indicated that he favours raising the debt ceiling for a longer time, we think that the Republicans’ move will lower the probability of a near-term default. On the other side of the coin, this will reduce pressure to find an imminent solution to the fiscal impasse, risking that the current government shutdown will drag on for much longer than we originally had thought.

 

…further boost sentiment…

Hopes of a fiscal breakthrough did not miss their impact on financial markets and further boosted sentiment, after it had already been lifted by President Obama’s announcement on Tuesday that Janet Yellen would take over the helm at the Fed. Indeed, equity markets surged, the VIX volatility index declined, while both the Japanese yen ad Swiss franc moved lower. Moreover, US Treasury markets calmed down. This manifested itself into lower US Treasury bill yields, while longer-tem Treasury yields rose (the opposite move of last Tuesday). This suggests that investors are less worried about a short-term default, which could also be seen in a decline in the US sovereign CDS spread, while safe haven flows into long-term Treasuries reversed. As a result of these moves, the 1-M TED spread (measuring the difference between 1-M LIBOR and 1-M Treasury yields) became less negative.

term Treasuries reversed. As a result of these moves, the 1-M TED spread (measuring the difference between 1-M LIBOR and 1-M Treasury yields) became less negative.