We continue to be stunned by the snowballing belief that a technical default by the US — in the event of a debt ceiling breach — might be no big deal, so long as payments were made soon.In a note out today, Citi’s Steven Englander goes further down this road, suggesting that while it might not be catastrophic to the fixed-income market, it could have real negative repercussions to the dollar, mainly owing to the message it would send the rest of the world.
Heres the nut:
Foreign investors will see 1) an additional unwanted tool of macro policy added to an already impressive array of non-orthodox policies; 2) another US policy debate that entirely centres on US domestic political convenience and ignores the interests of foreign investors; 3) confirmation that US policymakers favour policy options that will almost inevitably weaken the dollar, even while swearing up and down that they adhere to a strong dollar policy and are simply targeting domestic objectives. (You are about as likely to see a Higgs boson smiling out of your morning coffee as find an instance where the US policymakers of either party made a policy move intended to strengthen the dollar. See the recent essay by Buiter and Rabhari: “The ‘Strong Dollar’ Policy of the US: Alice-in-Wonderland Semantics vs. Economic Reality on the strong dollar policy.” )
Most importantly, 4) while a domestic bond investor can be made whole in a cash flow sense with virtual certainty, there is no way that unhedged foreign investors can be guaranteed that any FX market reaction will be unwound similarly. Domestic investors may have some reason to see themselves doing as doing a bungee jump, but foreign investors are not sure whether the tension limit is set for 200 feet above the ground or 15 feet below.
Again, we’re still more shocked about how many people are coming around to the technical default-is-OK line. Even Englander in the note thinks that a technical default accompanied by long-term structural reform (to entitlements) would be bullish for fixed income, despite yields still being at rock-bottom levels.
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