(Bloomberg News) Trading of credit-default swaps insuring U.S. Treasuries soared almost 80 percent as the deadline nears for plans to cut the nation's budget deficit and raise the $14.3 trillion debt limit to avoid default.
Traders bought and sold 41 contracts in the week through July 22, insuring a daily average of $250 million of U.S. debt, up from $140 million during the past month, according to the Depository Trust & Clearing Corp. The country was the tenth most traded among the 1,000 entities tracked by DTCC, with 1,063 outstanding trades covering $4.9 billion of debt -- a third of the total on German bunds.
Failure by President Barack Obama and congressional leaders to reach a debt agreement may force the government to delay bond payments, causing a credit event that would trigger insurance payouts. The parties are struggling to reach a compromise before Aug. 2, the date Treasury Secretary Timothy F. Geithner said the government will run out of options.
"While investors remain hopeful that the debt ceiling will be raised prior to Aug. 2, it is still unclear if such a move will be accompanied by a deficit reduction package that will be large enough to placate the ratings agencies," Barclays Capital strategists led by Bradley Rogoff in New York wrote in a note to investors.
Treasury Yields
For all the concern about a default, yields on the benchmark 10-year Treasury note are about 3 percent, below the average of 4.05 percent over the last decade and less than the average of 5.48 percent when the U.S. was running budget surpluses between 1998 and 2001.
The U.S. determinations committee of the International Swaps & Derivatives Association may call a failure-to-pay credit event after a three-day grace period, said David Geen, general counsel for ISDA. The industry group sets standards in the swaps market and runs the committee of dealers and investors that determine when payouts are made.
A technical default would allow swap buyers to be compensated even if the debt commitments are eventually honored.
"For CDS, if it triggers it triggers," London-based Geen said in an interview today. "If they fail to make a payment and the grace period passes, even if they cure it the next day, it still triggers."
Debt Auction
That would cause an auction to settle swaps based on the value of the cheapest securities available. While U.S. Treasury debt typically trades at or above par, some longer-dated bonds are quoted below face value.