The U.S. government shutdown risks putting a dent in both the dollar and Treasuries if it drags on. A quick resolution could do the same.
A drawn-out spending battle may collide with the looming debate over America’s borrowing limit, potentially raising the odds of a U.S. credit rating downgrade, as occurred in 2011. But some observers reckon the market reaction this time around would be different: Instead of driving a haven trade into Treasuries, concerns about the U.S.’s growing debt burden could reverse that flow, pushing sovereign yields higher and the dollar lower.
And the consequences of a near-term fix may be much the same, if it enables even more federal spending.
The government has been partially closed for more than a month. Yet U.S. stocks are up around 9 percent over that period, while the greenback has softened only slightly. The 10-year Treasury yield reversed a dip from early in the new year and is around 2.72 percent. But as the political deadlock stretches into a record fifth week with no clear sign of resolution, growth concerns are mounting and investors are starting to draw lines in the sand.
“The more this lingers on, the more that investors are losing patience with their dollar positions,” said Mark McCormick, North American head of foreign-exchange strategy at TD Securities. “There’s risk of a downgrade, there’s room for people to cut exposure to U.S. Treasuries.”
He’s describing a scenario in which the shutdown drags into March, inflaming the debate over the country’s debt ceiling. For some, that prospect is reminiscent of the market upheaval surrounding the debt-limit impasse under the administration of President Barack Obama, when S&P Global Ratings cut the U.S.’s AAA score. That action fueled a global sell-off in stocks, widened credit spreads and, ironically, spurred a flight-to-quality trade into U.S. debt.
While S&P, Moody’s Investors Service and Fitch Ratings have each flagged risks of the current shutdown, none say that a downgrade is imminent.
But the “brutal brinkmanship” of another debt-ceiling standoff could drive volatility in government bond markets similar to that of 2011, according to David Woo, head of global interest rates and economic research at Bank of America Corp. Except this time rates could rise, he said, given the “very large funding requirements of the U.S. government’’ and waning demand among foreign official buyers.
Economic Overflow
The situation doesn’t have to get that bad to worry investors, who are already concerned about how the public sector’s pain may ripple across the economy.