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An Update on the Debt Ceiling Crisis

We thought it would be both prudent and timely to give a short update on what we see happening in the markets given the ongoing debates in Washington. As most, if not all of you are aware, the debt ceiling will, in theory, need to be raised by August 2nd to avoid a default of the government’s obligations. While there are numerous commentaries on this issue floating around all types of media sources, we wanted to give you ours. All three of the contributors to this blog, Mark, John, and Charlie, have conferred over the past couple of days and have come to a consensus viewpoint. We still think there is a pretty strong likelihood that some type of deal gets done in Congress over the next couple of days. If there is no deal by the self-imposed deadline, we believe the following will happen.

The United States WILL NOT default on its treasury obligations. These obligations would include EE, I, and any other type of savings bond issue, TIPS, and fixed duration Treasures from zero to 30 or more years. Long before any of its obligations are at risk, the government would likely take other measures like temporarily suspending foreign aid payments, slowing down Highway expenditures, possibly closing down National Parks for a couple weeks, closing non-essential government offices and, possibly, delaying Medicare payments to states. All of these things would be temporary stopgap measures until a deal gets done in Congress, but they would allow the government to negotiate the tough patch until a deal gets made. For those getting Social Security money, it would continue without interruption.

With concern to stock prices, there is obviously some chance that the overall market could see some type of drop in the near term as some investors sell in anticipation of some problem ahead. It is our opinion that any near term drop will be short lived as, ultimately, stock prices reflect their underlying earnings, which have been pretty good overall.

As regular followers of this blog will most likely know, we tend to follow the TED spread pretty closely to get a feel for the underlying risk of a major shock to the markets. If the TED spread is rising rapidly, it would most likely imply some type of underlying risk. When it is low and falling, it indicates that the risk of a major shock is pretty small. The current TED spread chart is below:

ted-spread1

As you can see, the spread has actually been dropping of late, implying to us that there is actually less risk out there than most currently seem to believe.

The other key number we would look at to get a feel for the likelihood of a default is the 10 year Treasury bond rate. If there was a fairly high risk of some type of default, the rate should be rising pretty rapidly. However, as of today, the U.S. 10 year yield continues to be quite low, at 2.95%. For point of reference, if we look at Greek 10 year yields, they are in the range of 14.5%, implying a much higher risk of some type of default.

It is our view, given the information above, that the United States will not default in any way on its obligations. We will keep you updated as either circumstances or our views change.