Debt Ceiling Expectations

Why does the Treasury market seems substantially less concerned than David Brooks? The last I checked, the yield on 10-year Treasuries was about 3.04%. Assuming that a “default” has been priced in with non-zero probability, it seems that yields should be significantly higher than they are presently.

I think that there are two potential scenarios that explain why bond yields haven’t moved substantially in the midst of the debt ceiling debate. First, it is possible that bondholders have significantly underestimated the probability of “default.” As such, a failure to raise the debt ceiling would result in significantly higher yields. Second, the market is unconcerned about what is only a technical default. If an agreement cannot be met on raising the debt ceiling, it is possible that the Treasury could prioritize spending to pay bondholders first. In other words, they could withhold spending allocated for other uses and use the proceeds to make interest payments on the debt. In this latter case, bondholders are unconcerned about the debt ceiling because they assume that they will still get paid. In addition, a failure to raise the debt ceiling might send a signal to the markets that the U.S. is actually serious about reducing debt.

Admittedly, I do not know which, if either, scenario is correct. I also remain skeptical that purported experts know which scenario is correct.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s