On Sunday night, we brought you the shock commentary from top BofA credit strategist Jeffrey Rosenberg who argued that the US should actually default on the grounds that it wouldn’t be that bad (so long as the Treasury communicated that everyone would ultimately get paid in full) and that it would help bring about a fiscal compromise.We were sceptical on both of those fronts: that it wouldn’t be that bad, and that it would result in a fiscal compromise.
Post-downgrade of the US debt outlook, Rosenber is back, doubling down on his claim that default is the answer because it could help us get closer to a deal (though he still doesn’t explain how it would get us closer to a deal).
He also explains how you might go about profiting off of a spending compromise, namely, betting on lower long-term rates and a flattening of the curve.
Consider 10/30 flatteners on deficit compromise
Our argument for default is not in favour of default but as a means for achieving the political compromise necessary to bring about long term fiscal sustainability. The benefit of such a compromise would be to lower the long run inflationary consequences of failing to reign in current budgetary dynamics. As the market response today to S&P’s downgrade illustrated, the relative level of yields between long and short dated maturities can be expected to increase on the failure to address the budget issues. Though the long run shape of the yield curve will have mainly to do with monetary policy’s impact on inflation, success on reaching a budget compromise should contribute to a near term declining differential between long and intermediate term interest rates. Note however that in the absence of such an agreement, the 10 30s curve may remain under steepening pressure. Such a view remains the outlook of our interest rate strategy team as recently outlined here (US Rates Alpha, 28 January 2011).
The interesting here is that Rosenberg’s call can win in multiple ways. If you think the 30-year rate is somehow reflective of US credit risk, then a contractionary fiscal policy would be bullish for long-term Treasuries. And if you think that rates simply reflect growth prospects — lower rates signifiying declining growth — then again, the 30-year bull case is a winner.
Only, it would seem, in the non-contractionary, non-recessionary path does his advice not make sense.
The call aside, we’re still pretty stunned by the number of pro-defaulters (an outcome Secretary Geithner has called “unthinkable”) and we have to think that notes like these make the odds of something drastic happening in DC even more likely.