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Even with all the sturm and drang over the debt ceiling, most around Washington and Wall Street are operating under the assumption that Congress and the Biden administration will find a way to keep paying U.S. bondholders.
That doesn’t mean the economy will escape unscathed, according to PGIM Fixed Income chief global economist and former Biden White House official Daleep Singh.
“Major economies are getting pulled apart from within due to unprecedented levels of political polarization,” said Singh, who advised President Joe Biden on national security and economic policy. “The debt ceiling drama is symptomatic of that polarization.”
The growing fascination with payment prioritization – in which Treasury would pay debt obligations while withholding checks for other government programs — ignores how credit agencies could ding the U.S. for failing to deliver on basic benefits, services and contracts. And while prioritization might let certain financiers whistle through the graveyard — Zach has more on that here, ICYMI – the outcome “would be only fractionally better than default,” Singh said.
“If we don’t make payments on time for other obligations, what are the credit agencies going to do? And if you have multiple credit agencies that have downgraded the U.S., does that force selling among investors that have investment mandates that restrict them to [securities with] triple-A ratings?” he said. “This is the lifeblood of global financial markets.”
If credit agencies downgrade Treasury securities en masse, the cost of borrowing (and insuring against default) will go up. Any financial asset that’s priced on its spread to Treasury yields would feel the effects. Mortgages, credit cards, corporate bonds – everything gets more expensive as soon as investors start attaching more risk to the likelihood of the U.S. meeting its obligations.
That’s a much bigger danger after repeated, protracted battles over the debt ceiling, Singh added.
“The way in which investors across the world think about the riskiness of Treasuries is going to be different,” he said. “That’s a legitimate concern that nobody can discount at this point.”
Obviously, there’s some precedent for that. S&P downgraded U.S. debt from triple-A during the 2011 debt ceiling crisis; an event that shook markets and threatened the economy’s emergence from the financial crisis. Even though key areas of the economy are on better footing than mid-2011 — the unemployment rate is now a fraction of what it was at the time — fiscal policy has gotten even more complicated.
The debt-to-GDP ratio has spiked in the intervening decade and foreign investors now hold trillions more in Treasury securities. What’s more, after being rattled by the Covid-19 downturn in early 2020, there are now questions about the long-term stability of a Treasury market that’s supposed to be terra firma for investors.
There “really wasn’t that type of concern prior to 2011, even through the GFC,” Singh said.
The political climate is also more toxic. Speaker Kevin McCarthy’s(R-Calif.) tenuous grip on a narrow majority hinges on his commitment “to a fiscal path that’s incompatible with where the administration is willing to go,” Singh said.
IT’S TUESDAY — And Sam is still recovering from San Francisco’s dismal showing in Philadelphia this weekend. Tips will make him feel better. Send those to Sam at [email protected] and Zach Warmbrodt at [email protected]. You can also find us on Twitter @samjsutton and @zachary
Assistant Treasury Secretary Alexia Latortue will deliver a virtual keynote at the DAC Community of Practice on Private Finance for Sustainable Development Conference 2023 at 8 a.m. … Employment Cost Index will be released at 8:30 a.m. … Rep. Jan Schakowsky , (D-Ill.) and Rep. Darin LaHood (R-Ill.) will appear at a Semafor event on ecommerce at 8:30 a.m. … The Fed’s Federal Open Market Committee will begin its two-day meeting at 9 a.m. …
BANKRUPTCY — From Sam: “The epic implosion of digital exchange FTX is sparking a torrent of lawsuits and legal threats among crypto financiers scrambling to salvage what they can from the wreckage. Small investors stand little chance of being made whole. The meltdown is giving momentum to efforts in Congress and by federal regulators to create new rules and clamp down on businesses whose practices contributed to massive losses over the last year … They are also fueling calls to enforce the laws and regulations that are currently on the books, which the industry has fiercely resisted.”
ECONOMIC OUTLOOK — The International Monetary Fund is projecting the global economy to grow by 2.9 percent this year amid cooling inflation and moderating geopolitical risks. While the forecast is less gloomy than what was predicted in October, “low growth in 2023 reflects the rise in central bank rates to fight inflation–– especially in advanced economies––as well as the war in Ukraine,” according to the report.
ON THE FLOOR — Our Eleanor Mueller: “The House on Monday unanimously passed a bill intended to protect seniors from investment fraud, as part of the first batch of Financial Services legislation on the floor under Chair Patrick McHenry (R-N.C.).”
MUSK DIRECTS TWITTER INTO PAYMENTS — FT: After registering as a payments processor with Treasury late last year, Twitter has now “begun to apply for some of the state licences it would need in order to launch, these people said. The remainder would be filed shortly, in the hope that US licensing was completed within a year, one of the people said. Then the company would seek to expand to gaining regulatory approvals internationally, they added.”
FACE/OFF — Bloomberg’s Steve Matthews and Michael Mackenzie: “Jerome Powell and Wall Street are headed for another face-off this week as the Federal Reserve seeks to slow its inflation-fighting campaign without signaling a readiness to stop. Despite 2022’s slew of interest-rate hikes from Chair Powell and colleagues, financial conditions are the loosest since last February as investors bet fading inflation will allow the central bank to soon cease raising borrowing costs and then cut them later this year.”
— Meanwhile, liberal watchdog group Accountable.US is urging the Fed to avoid rate hikes that could hamper the labor market.
HERE WE GO — WSJ’s Harriet Torry and Joe Pinsker: “The engine of the U.S. economy—consumer spending—is starting to sputter. Retail purchases have fallen in three of the past four months. Spending on services, including rent, haircuts and the bulk of bills, was flat in December, after adjusting for inflation, the worst monthly reading in nearly a year. Sales of existing homes in the U.S. fell last year to their lowest level since 2014 as mortgage rates rose. The auto industry posted its worst sales ye a r in more than a decade.”
RICK SCOTT — Sen.Rick Scott (R-Fla.) is demanding the Federal Reserve explain why it’s taken so long to reduce the size of its balance sheet, arguing that it “begs the question of whether the FOMC is actually committed to its word and getting done what’s right for the American people.” A Fed spokesperson said the central bank had received the letter and plans to respond. HUNGRY FOR MORE DISCLOSURES — Our Declan Harty: SEC Commissioner Caroline Crenshaw is calling for a beefier disclosure regime in the private markets where, the Democrat said Monday, many companies have had “unfettered access to capital” that has had a “bloating effect” not unlike a Very Hungry Caterpillar who ate a little bit too much on one fateful Saturday in Eric Carle’s children’s book. Crenshaw pointed to FTX, Theranos and WeWork in the speech as examples of the harms that come from a lack of disclosure, even if big-name investors pile in left and right.
NEW RULES — Also from Declan: “Under a new proposal, SEC employees would be barred from buying exchange-traded funds and mutual funds that are focused on the financial sector in a push to ‘avoid conflicts and appearance concerns,’ the agency said Monday. The change would also apply to employees’ spouses and children who are still minors.”
IT’S OFFICIAL — Deputy Treasury Secretary Wally Adeyemo welcomed Laurel Blatchford to her role facilitating the implementation of Inflation Reduction Act. Blatchford, a former progressive strategist with Uplook Advisors, “will help ensure the IRA’s implementation delivers on the law’s promise to both drive historic investments in the clean energy economy and modernize the IRS to better serve honest taxpayers,” Adeyemo said.
The Securities Industry and Financial Markets Association promoted three of its associate general counsels — Kevin Carroll, Melissa MacGregor and Kevin Zambrowicz – to deputy general counsel.
Marina Torres, a former federal prosecutor and candidate for Los Angeles City Attorney, has joined Willkie Farr & Gallagher as a partner in the law firm’s white collar defense practice.
TETHER CONTRACTS FORMER TRUMP OFFICIAL — Tether has hired Continental Strategy, a lobbying firm led by President Donald Trump’s former ambassador to the Organization of American States Carlos Trujillo, to beef up its presence in Washington. Policymakers have repeatedly signaled their concerns about the stablecoin issuer’s emergence as a key player in crypto markets.
ENFORCEMENT — As crypto markets crashed, U.S. state and federal regulators completed a record number of enforcement actions against the nascent industry in 2022, according to a new report from the blockchain analytics firm Solidus.
PUBLIC INFO — Reuters’s Jonathan Stempel: “A U.S. judge on Monday said the names of two people who helped guarantee bail for indicted FTX cryptocurrency exchange founder Sam Bankman-Fried should be made public.”
— Bloomberg’s Ava Benny-Morrison: “FTX co-founder Sam Bankman-Fried asked to meet John J. Ray, the executive who replaced him as the crypto empire descended into bankruptcy, weeks after being charged with orchestrating fraud at the company, newly released emails show.”
