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Bond Market Insights - Mon, 15 May 2023

After rallying through the auction cycle last week, the US treasury market retreated after the University of Michigan data showed inflation expectations as still elevated. Fed's Bowman was whistling a hawkish tune on Thursday night, which had already dampened market enthusiasm. She explicitly noted the data has not provided confirmation of a slowdown in inflation or employment, and if the data were to remain hot the Fed would consider a hike next meeting.

On the data front Deutsche Bank points out that nearly half of the recent rise in US initial jobless claims can be attributed to just one state, Massachusetts. Continuing claims have increased as well, but by much less than initial claims, and sit more comfortably with relative payrolls resilience.

This morning Asia IG spreads are opening pretty much unchanged on back of the rates sell-off. There are a couple of things to focus on. The Thai election results to Adani board approving a ~2.6bn USD equity raise. AT1 continues to be very active with good PB and RM demand. Overall same theme remains – outright buyers active as are RM/lifers in adding paper. Issuance remains relatively light.

Headline “US Defaults”.. can you imagine that happening outside some dystopian novel?

The repercussions of a miss-match of US treasuries caused the demise of Silicon Valley Bank. A default would hit every bank as their Liquidity Coverage Ratios (LCR) are determined by their holdings of High Quality Liquid Assets (HQLA). What would happen if those assets proved illiquid.

Globally corporates have increasingly used cash management accounts, wherein overnight US$ balances held in their accounts are swept into investment accounts that put this cash into yielding, high quality, short term instruments such as government bills, bonds and repos, as well as agencies, which enjoy the governments patronage.. oops.. The recent rush into money market accounts will have run into a brick wall. The status of the US$ as the leading global reserve currency would be lost.

But this can be avoided and most still expect a last-minute deal on the debt ceiling. Democrats seem to have to abandoned their clean raise stance, so now the Republicans will have to cede most of the spending cuts in the bill they passed a fortnight ago. In 2011 President Obama agreed to spending cuts which almost pushed the economy back into recession. GDP growth halved to just 1.3% in the year to Q2 2013.

If the Republicans maintain their stance the President could invoke the 14th amendment which reads that “The validity of the public debt of the United States, authorized by law... shall not be questioned”, arguing that it stands above the debt ceiling legislation, rendering it invalid.

He would then instruct the Treasury Department to issue new debt, over the ceiling, and invite Republicans to sue. The case would quickly go before the Supreme Court

The court then can either issue an injunction to prevent the debt issuance while they consider the case, which would trigger a default, or they can allow the issuance and then rule on the substantive issues in due course. It seems unlikely that the Supreme Court would decide that the statute either does not contradict the constitution or effectively overrules it.

It is important to note that if the two sides agree to a $1.5 trillion increase, it will only buy about 7 more months until the government runs out of money again.


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