Then Why Are Treasuries Up?

By James Kwak

The Times:

Markets Stumble on Deficit and Debt Worries

Stocks in the United States and Europe fell more than 1 percent on Monday in the wake of the publication late Friday of the results of stress tests on European banks, and as investors remained wary about the debt-ceiling talks in Washington.

The Journal:

Stocks Slump on Debt Fears

Stocks fell as the combination of anxieties about debt in the block of euro-using nations and a lack of progress in U.S. debt-ceiling negotiations sparked a selloff.

If people are worried about the debt ceiling, then why are short-term and intermediate-term Treasuries flat or slightly up? Presumably the mechanism by which a debt ceiling breakdown would affect stocks would have to go through Treasuries somehow.

37 responses to “Then Why Are Treasuries Up?

  1. But worry over the debt ceiling is a perfectly reasonable explanation for falling stock prices and falling interest rates. Worry over default would explain falling debt and equity prices, but it’s stupid to worry about bond default. What would go unpaid is other forms of payment, and those other forms of payment represent income and spending capacity to millions of people. If we continued to make bond payments and failed to make other forms of payment, there would be a recession – bad for stocks, good for bonds.

  2. 1) Everyone knows it’s all political theater. Except for a few Tea Party loonies, no one is seriously going to risk getting blamed for messing up US credit, and creating financial meltdown.

    2) If there was an impasse, interest would still get paid, somehow. Given the choice of not paying government employees and entitlements, and not paying China and other foreign investors… you cut off Grandma. Why is left as an exercise. (A hint: politics, and not wanting to spike the interest bill on $10T in debt.)

    3) And if there was a government shutdown, the economy would tank, leading to a stock market correction, QE3 bond buying by the Fed, and lower inflation expectations.

    So if you’re a bondholder, a debt ceiling impasse is unlikely, and probably means you get your interest, no new bonds are sold, prospects for the economy and inflation are diminished, and the Fed eases policy more (buying bonds).

    Even though it might seem counterintuitive that bonds go up while people publicly dither about whether to pay them, it’s actually kind of rational, in the usual reverse psychology sort of way.

  3. from what i heard there is talk of a 90% haircut on some countrys bonds, then a bailout to all recipients execpt the countrys that defaulted. Counterintutive maybe, fire in the theater, most definately.

  4. Lavrenti Beria

    Not a word at this site about the Elizabeth Warren screwing? Or about Obama’s predictable offer to gut Social Security and Medicare? I mean I knew Quack was one of Obama’s ducks, but this is transparent enough to be funny.

    Lavrenti Beria

  5. CBS from the West

    Oh, come on! Every day the papers and commentators offer some vaguely reasonable sounding explanation for why the markets moved up or down. Those explanations are about as meaningful as reading the entrails of a goat. There is a lot of random movement in financial markets–and the stock market is generally much more volatile than bond markets. Nobody really knows why the markets move one way or another. I’ve never heard of “sophisticated” investors using stuff like that to formulate an investment strategy.

    It’s just part of the bread and circuses aspect of our empire’s decline.

  6. Lavrenti Beria,

    James touched on your second point about Obama and spending cuts in his last post and there have been other posts on the subject previously – though mostly aimed at Republicans – so it would be good to hear Baseline’s view on why the Democratic leadership seems intent on gutting these social safety nets but it is unfair to claim there is “no word” about it. Also, Warren recommended the current nominee and often stated she would not run the agency. IN fact, there are rumors she may be making a run for Senate.

  7. I’ve been reading about the CDS on US treasuries, which I hadn’t been aware of before. It seems there’s quite a casino built up betting against treasuries with these CDSs. An entitity doesn’t actually have to own treasuries to buy these CDSs. I have no idea who sells this “insurance,” but I am wondering who will be left holding the bag if the US defaults and the owners of these CDSs want to cash in their chips. It’s got to be bigger than what happened with AIG and other debt. I’d really like to know who issues these CDSs.

  8. Clearly, buyers and holders of US treasuries believe that no matter what happens between now and August 3, the US will pay all principal and interest. At worst a little late.

    Assuming no agreement is reached by August 3 (a made up date with no significance that I can see) what will change? Will the sky fall? Will the banking system collapse? Maybe Washington will go on vacation which wouldn’t be a bad thing.

  9. those anticipating a US default will insure near term debt thru credit default swaps…even on june 15th, the cost of CDS to insure US 2 year debt was higher than that of the cost to insure the same for brazil or italy..

    http://twitpic.com/5c19bs (h/t ken @ angry bear)

  10. Bob Kennedy

    As Krugman keeps pointing out, borrowing by the U.S. gov. is at historically low interest rates. Why? As some people have pointed out, one major reason is that the U.S. economy is actually awash with cash–held by banks, corporations, and wealthy citizens. The government’s “debt crisis” is a manufactured reverse Potemkin illusion created by ludicrously low tax rates on upper income levels–even without taking into account ludicrously high “defense” (sic) spending–and by elevated spending on recession-related decelerators like unemployment, food stamps, etc. There would be no immediate “debt crisis” at all If the political will was there: i.e., if the Republicans hadn’t turned into a fundamentalist sect that enforces strict adherence to dogma and promotes incredible political cynicism–nothing takes precedence over getting rid of Obama, even the national credit and welfare–and if Obama weren’t the President most interested in being “mature” by being “non-partisan” since John Adams, who was, it should be noted, a one-termer.

  11. Treasuries and other financial assets continue to bounce because there is a lot of paper money out there looking for a return. The Dow has to go higher because of the real, underlying inflation rate. Sadly, the Dow is actually losing ground in real terms if you reckon that real CPI is in double digits.

  12. Worries about Europe might be important. They might trouble the stock market because of “contagion” effects, but help the bond market because of the “flight to safety.” From what I gather, many bond investors believe not only that they’ll get paid, but the debt ceiling will get raised.

  13. Moses Herzog

    Christopher Whalen above says: “Treasuries and other financial assets continue to bounce because there is a lot of paper money out there looking for a return.”

    Uuuuuh, gee Chris, I didn’t think buying things (treasuries/government bonds) that are supposedly on the verge of default is conducive to “looking for a return”. Wow Christopher, I guess if I thought that made any logical sense at all I might buy some garbage book that person was selling.

    More to a taste of reality, default is a scare tactic to get middle class American’s eyes off the ball of the true problem: Low tax rates on rich individuals and low corporate tax rates. Which guys like John Boehner, Eric Cantor, Mitch McConnell, and Dick Shelby pray their more ignorant constituents never wake up to. See here: http://jessescrossroadscafe.blogspot.com/2011/07/us-is-not-high-tax-corporate-country.html

    I know the TBTF bankers that feed Mr. Whalen and feed Andrew Ross Sorkin most of their better kernels of propaganda don’t appreciate these facts being brought up, but so be the little details known as reality.

    It might also be added that much (not all) of the increase in prices has been due to speculators on the commodities exchanges, who get to play no rules cage match with each other because years ago (Gramm–Leach–Bliley 1999) Republican Senator Phil Gramm worked extra hard to castrate the SEC and CFTC and largely succeeded in that neutering.

    A free opinion (free opinions are usually worth what you paid for them) from an average joe to other average joes: Instead of worrying about default, I would keep my money in mostly cash now and wait for the next hedge fund, mutual fund, broker analyst, bank analyst panic attack, and afterwards pick up equities on the cheap. Happy hunting people.

  14. Treasuries go up in a risk off scenario because that’s what the market expects them to do on the back of recent past history seems to be the consensus argument.

    But you’re absolutely right to ask this obvious question. The mkt has become ludicrously complacent about the solidity of US Treasuries. Once the mkt wakes up to the fact that Treasuries providing almost no return in an inflationary environment actually makes them a very risk asset and the illusion is shattered, we’re in for a shocking bond market collapse (think 1970s). This is going to happen soon because whilst the Fed has managed to avoid rising yields thru massive QE buying, the current debt ceiling impasse demonstrates that there is almost no political will left to continue this misguided policy.

    Bill Gross hasn’t been shy about telling you this. You’ve been warned.

  15. Moses Herzog

    Jennifer Taub was on a KPFK radio show called “Background Briefing”. They get some good guests on occasionally. Jennifer Taub was on the show on the 17th discussing corporate governance and the decision to evade leadership by not choosing Elizabeth Warren as head of CFPB. Miss Taub seems to give a timid apology for Obama’s lack of leadership in this decision. You can listen on this link and Miss Taub’s remarks start around the 20 minute mark.
    [audio src="http://archive.kpfk.org/parchive/mp3/kpfk_110717_105955bbriefing.MP3" /]

  16. Hoisington can see what’s coming but are complacent on timing.

    “The Fed may resort to another round of quantitative easing, or some other untested gimmick with a new name. Such undertakings will be no more successful than previous efforts that increased over-indebtedness”

    That’s right, and I’m sure Bernanke would like to, but the Fed’s ability to engineer low rates is dependent on the political will to allow them to do so. The current debt ceiling impasse and threat of agency downgrade are a red flag, indicating just how little political will is left, particularly in view of the failure of QE. In other words, the day of reckoning regarding “the massively inflated level of debt and the prospect of higher interest expense for decades to come” is actually much closer than they think. One potential near term trigger that could force Hoisington and other bond bulls out of their compacency is an agency downgrade. This is looking ever more likely and if it leads to treasuries becoming ineligible collateral, could force a wave of selling.

  17. Bob Kennedy said, “The government’s ‘debt crisis’ is a manufactured reverse Potemkin illusion created by ludicrously low tax rates on upper income levels … ”

    What are the correct tax rates on upper income levels? What levels are “upper income?” Show your work.

  18. Why is it that people blame a president for not appointing a person who admittedly did not want the job. Elisabeth Warren worked her fingers to the bone creating the dept, and some busy bodies thought that with her in the top position they would be better able to manipulate its decisions. And rich people have been nuetering judges to get their way for DECADES, but in the end it all comes out in the wash.

  19. Cordray is a super choice for this position, but since it seems very likely that he, as Warren in his place, will never be confirmed in Obama’s first term, I’m not sure what the angst is all about. Should the miracle occur that the Senate gets around to an approving vote, I’m sure Cordray will do a fine job of it. Republicans took all state offices in Ohio and the most disappointing to me was Cordray losing to a much inferior DeWine. A little off topic, but there should be giant red lights flashing in Obama’s campaign that such a result was possible in Ohio, plus the new Ohio legislature and governor just enacted voting changes that seem transparently aimed at depressing the vote in groups more inclined to vote Democratic, by solving non-existant problems of voter identity and shrinking the voting time window. I can tell you that Cincinnati-area Republicans were livid that in 2008 folks they counted on not getting their act together to get to the polls on election day had a lot of help getting them there by Halloween….something had to be done!

  20. Quite the collection of pseudonyms here! Lavrenti Beria? (I don’t get it. Shouldn’t you just be lurking?) Moses Herzog! (Very appropriate for a blog commenter.)

  21. Speed,
    90% marginal tax rate in the 1950’s under Eisenhower, 70% under Kennedy, Reagan slashed to below 40% in first year, then actually RAISED taxes to make up for the ‘ridiculous’ deficits that were building(yeah, I’m laughing too). Bush 1 and Clinton kept them around 40%, and both raised taxes to help the deficit(no, can’t make this stuff up..) Bush 2 slashed dividends, capital gains, said upper marginal rates, etc. meanwhile spending like a triple-down-drunken sailor, creating massive government programs like Homeland Security(read:cash grab), all the while saying government is the problem(read: your government, not mine).
    Marginal tax rate kicked in over a Million.
    1980-U.S. the largest creditor nation in the world, today…

  22. @ speed

    Not sure if this helps,… but the rich should be taxed at 65%, and Cap Gains @ 35% +/+

    Ref: Take your taxes and shove em!
    @ 40% has always been the threshold precipitating revolt !

    http://www.ctj.org Note: { PDF. Type”Taxday (Year) into search box. ie. 2010,etc., etc.,…}
    :-)

  23. With Geithner in charge, the holders of treasuries will get paid even if no deal is reached. It will be government employees, government contractors and entitlement recipients who will get screwed. All of that will reduce demand , slumping the economy and thus bad for equities.

    Say a deal is reached — holders of treasuries still get paid but presumably the deal involves large budget cuts, or essentially a smaller version of the result if no deal is reached. Again bad for equities, ok for bond holders.

  24. 1 Kings said … I don’t know what he/she said.

    earle, florida said, “Not sure if this helps, … ”
    It doesn’t.

    “Since 1980, statutory marginal tax rates have fallen dramatically. The highest marginal income tax rate in 1980 was 70%. Today [2008] it is 35%. In the year Ronald Reagan took office (1981) the top 1% of income earners paid 17.58% of all federal income taxes. Twenty-five years later, in 2005, the top 1% paid 39.38% of all income taxes.”

    “With the Kennedy tax cuts of the 1960s, when the highest tax rate fell from to 70% from 91%, the story was the same. When you cut the highest tax rates on the highest-income earners, government gets more money from them … ”
    http://online.wsj.com/article/SB120122126173315299.html

  25. I’ve been asking the same thing about Japan for the past 10 years. Do you ever get the sense that what needs to be done cannot ever intersect with political reality?

  26. My understanding (as I think some have mentioned above) is that it is assumed that bondholders would be made whole with at most a slight delay in payment, while the knock on effects from reduced spending would tip the U.S. economy back into a recession, which obviously could drag down stocks.

    At its core this seems to be entirely driven by the assumption that the U.S. would never shortchange bondholders.

  27. @ Speed

    Your to predictable? This is a classic take your eye off the ball, while I (Obama or Romney) setup a post-election “Value-Added-Tax” proposal. Sure, there’ll be a “Budget Amendment” bandied about – just won’t fly, but great rhetoric,…and the best of both world’s will gravitate to the consumption hungry poor/ middle class has-been. This will come to be when the Bush Tax Cuts are relegated to the trash bin, and thusly sanctioned with a “yea” by both parties as an anomaly. Indeed, a neo-anti-polarity flip-flopper… screwing the working class to the ground as a defused storm never approaches? The “B(v)AT Belfry” will feed quano to the consumer as that of a delicate,… succulent dish of Chiioptera, garnished with hemlock oil!

    @ Eric

    Ms. Elizabeth Warren is finding it hard to get support from Kerry,and the Massachusett political caucus,.. ? Kerry will be at a pow-wow (three weeks?) on Martha’s Vineard in a few days discussing who if anyone will run against Brown. I really doubt Warren wants to dirty her name, or that Obama actually wants to support her (quite perplexing to say the least) seeing that the big-money boys dislikes her, and conversely, Obama wants dearly the big-money boys donations. The only caveat I can see here in Mass. is that the people are very, very,… extremely disappointed with Obama BS’, and might push hard for Warren to run,.. to be continued?

    PS. Scott Brown is somewhat liked in Mass. and has garnered huge donations for his full-term senatorial race,.. but the people in Mass (I’m from the Boston Area, originally…so I have a feel how they think) don’t like his voting record when it comes to important progressive votes, always siding with the GOP!
    If Elizabeth wants, or gets pushed into the race, (whether she likes it or not?) she’s got to get the word out by September, and raise some serious cash. Why? Bcause her name isn’t known to well in the average voting household, and the globe-trotting derelict Kerry… I truly believe would be intimidated by her integrity (John Kerry is a useless Senator that’s done nothing for Massachusetts accept for carrying Kennedy’s rollex) ! (JMHO)

    Thankyou James and Simon

  28. Because 99% of the time no one actually knows why the market went up and down, they just make it up…

  29. @speed – Might the fact that all the growth in the nation is going only to those 1% have anything to do with getting more money from them?

    Consider this:
    In 1980, in country A with a population of 11, 10 people make $100 each and 1 person making $1000. Everyone pays 50% tax. The richest person pays 50% of the taxes.

    In 2010, in the same country, 10 people make $50 each, and 1 person makes $5,000. Tax rates drop to 10%. The richest 1 person now pays ~90% of the taxes. But the government is still making less, and the vast majority of the country is in worse shape.

    Now I am not suggesting that this is indeed the case in the US. What I am proposing is that the arbitrary statistic you picked, is absolutely meaningless out of context. Unfortunately, this is par for the course in the WSJ. (e.g., the classic Lucky Duckies, who apparently pay no tax (assuming you define tax as income tax), and are living oh-so-awesome lives, yet no one with a job wants to trade positions with them…I wonder why.

  30. As the very first commentor kharris says, if the debt celing is not raised the U.S. will not default on it’s bonds. The administration is not going to ruin the full faith and credit of the United States. It will continue to make the bond payments and instead cut very other form of federal government spending (akin to a partial government shutdown).

    Hence the big institutional investors, who drive the bond market, know that U.S. treasuries are safe. However, equity markets are much more volatile, so in the short run (which is meaingless for equity markets) the market may bounce down. Also, there is fear that if the Federal government, the biggest spender in the U.S. economy, cuts federal spending we will go back into a recession and that will hurt equity returns.

    So the fascinating part is that this is a tacit admission on the part of the big institutional investors, i.e. the financial industry, that Keynes is right. Government spending stabilizes and stimulates the economy. Cutting government spending will hurt it.

  31. I find myself remembering the Ford administration’s “Drop Dead!” to New York City in 1975. Many esteemed figures had told Ford that New York was “too big to fail”, but it was the German government that convinced the president behind closed doors. Who is saying what to whom now? And are the Tea Partiers and Republicans too dim or too delusional to get it? (And what are we to make of Obama, surrounding himself with the likes of Larry Summers?)

  32. I agree with those suggesting that the US is very unlikely to default on bond payments (at least with the term of this administration) but its also true that an imminent default isn’t a neccesary (although definitely is a sufficient) condition for a bond market collapse. In the near term, the threatened ratings downgrade could prompt this (see above comment on forced selling due to repo turmoil on downgrade). Further foreign central bank moves away from holding dollar assets could also prompt this (tho current Eurozone turmoil reduces this threat). Also worth bearing in mind that whilst deficit cutting in the long term would certainly be bond positive, in the short term it might have the opposite effect if resultant declines in GDP are seen to be more than transitory by bond investors. Just because the US economy can’t afford higher rates doesn’t mean they’re not coming….

  33. addicted44 asked, “Might the fact that all the growth in the nation is going only to those 1% have anything to do with getting more money from them?”

    I reject your premise. Please provide data to support it. In the meantime, here is some data (DATA!) from Arthur Laffer.
    http://www.heritage.org/Research/Reports/2004/06/The-Laffer-Curve-Past-Present-and-Future

  34. Del Fitchett

    Nothing to be too surprised about in the price of US Treasuries. After all, the principal traded alternatves are Euros and Sterling. What has been happening to Swiss franc government securities?

  35. Data from “Laffer” indeed. Now there’s a trustworthy source.

    Anybody can google the CBO’s data on changes in distribution of income over the last 30 years. It shows that, except for about the top 2-3 percent, everybody’s else’s share of the national income has gone DOWN. The top 1 percent of earners went from under 10 percent of the national income in 1980 to 17 percent in 2007. Presumably, that figure has increased significantly since then given high unemployment among the middle class combined with high corporate profits and at least partially recovered stock prices.

  36. Bob Kennedy

    Data from “Laffer” indeed. Now there’s an unbiased, trustworthy source. In lieu of Laffer’s, let’s say, filtered data, anybody can google the CBO’s data on division of the national income across the population from 1980 to 2007. During that period, the income of the top 1 percent of earners went from 7 percent of national income to 17 percent, a figure that has obviously only gone up in the last 4 years given the combination of high unemployment with solid corporate profits and continuing high executive salaries. In fact, according to the CBO, from 1980 to 2007, the only income bracket to increase its share of the national income was the top 2-3 percent and everybody below the 95th percentile experienced a DECREASE in their share of the national income–by a fairly consistent 2-3 percent across all income brackets until you get near the top. And one note on the effect of such a shift: as the head of the Fed during the depression observed (see Reich’s latest book), it decreases general demand (the rich don’t spend as high a percentage of their income on consumer goods as the rest of us) and encourages speculation and bubbles since there’re so many free dollars chasing high-yield investments–hence, the creation of so many ludicrously crappy “investment opportunities” during the dot.com and housing bubbles.