Within a few weeks of the Oct. 17 deadline, the U.S. Treasury would presumably run out of cash and have to delay payments.
So what would that actually mean for markets?
In a recent note to clients, HSBC’s Steven Major and Lawrence Dyer say that a delay wouldn’t be all that bad for U.S. sovereign debt and those that hold it.
“History suggests that the U.S. government will ultimately compensate investors for payment delays. The payment for a portion of the 26 April 1979 T-Bill was delayed for a few days and affected some retail investors,” they write. “Ultimately, new legislation provided for payment to compensate holders for the interest due as a result of the delay.”
This time, a missed payment would push rating agencies to give U.S. sovereign debt a “selective default” (SD) rating. But, “we see important differences between a potential missed payment by the U.S. Treasury and the regular defaults that are part-and-parcel of the credit markets.” From the note:
It is a measure of how unusual the current situation is that those sovereigns that have been SD in the past have normally end up as sub-investment grade i.e. rated ‘CCC+’ to ‘B.’ However, in the current case, such an outcome would surely be a farcical situation for the rating business, when the world’s largest and wealthiest country would be rated below those that are compared with it.
If Treasury has to delay payments, Major and Dyer say bonds could be bifrucated into the “delayed” component and the “normal” component, and bonds without delayed payments could continue to be traded as usual.
Essentially, there are mechanisms in place to subdue the “damage” of delayed payments, they argue. “If the delayed coupon is stripped from the rest of the bond (as it is owed to the holder of record), then the rest of the bond’s cash flow looks like those of any other bond that has no coupon delay,” Major and Dyer write. “The bond could continue to be traded as if there were no delay.
The “impact of a U.S. Treasury payment delay on the U.S. bond market may well be a managed disruption, not a catastrophe,” they conclude.