Photo: Library of Congress
Things are moving really fast on the debt ceiling front, and news that was valid an hour ago is no longer valid.The latest actual NEWS is that the John Boehner 2.0 plan (revised to be more conservative after an initial Tea Party revolt and bad CBO score) is looking like it’s going to pass the House, and get sent to The Senate.
Goldman’s Beth Hammock, its head of UST trading, shares these thoughts on a possible downgrade:
* This is looking like the most likely outcome at this point as both proposals look to get us here. Impact of downgrade will likely be a risk off trade immediately perversely benefitting the front end of the US rates markets, with deeper impacts felt over time as investors may look to diversify away from US dollar investments. On a US downgrade we are likely to see a downgrade of GSEs, exchanges, defeased munis/MBS and possibly some banks. This may also mean an increase in haircuts on US Treasuries (even more significant then CME’s Monday announcement) – this may drive collateral calls and a need for more short dated paper. I do not think we will see immediate selling of USTs by either 2a7 funds or other money managers as Treasuries are generally held as their own asset class independent of ratings. However, over time, a AA US sovereign could mean reduction in foreign interest in US debt, weaker US dollar, as well as rescaling of ratings of US corporates and banks (See S&P report “The implications of the US Debt Ceiling Standoff for Global Financial Institutions” dated July 21, 2011).
* Immediate move: UST front end rallies to 30bps, long end sells off 20-30bps with 5yr notes being the pivot point. Agencies and MBS will feel immediate widening pressure, but will likely find strong buyers at recent wides.
* Longer term move: Yields in the US shift up25-50 bps over time, with the back end underperforming. Agencies and MBS 5-20bps cheaper.