Graphic: How investors are trading the U.S. debt ceiling

Hubbell

05/05/2023 10:48

LONDON, May 5 (Reuters) - A Washington stalemate on
whether to increase the U.S. debt ceiling has raised the risk of
a default as early as June and threatens a fresh rout in
financial markets. 
    While analysts reckon a crisis will be averted, just an
increased probability of default would send shock waves across
markets, said Janus Henderson's global head of fixed income Jim
Ceilinski.
    Veterans of a 2011 standoff, when the U.S. reached the brink
of default and suffered a credit rating downgrade, say
negotiations may be even tougher this time. 
    "We're in an environment where the political backdrop is so
much more divisive now than it was in 2011, which is making
investors that little bit more fearful," said Invesco's director
of macro research Benjamin Jones.
    Here's a look at how some are positioning. 
    1/ PLAY T-BILLS, BUY USTS
    Yields on some short-dated Treasury bills have shot up -
two-month T-Bills have surged to over 5%, rising for six
straight weeks  US2MT=RR .
    BlackRock says  BLK.N  it's been buying Treasuries in
anticipation of an economic slowdown and a protracted debt
ceiling fight.
    Unigestion's head of investments, Olivier Marciot, said he
was taking advantage of higher yields on longer maturity T-Bills
likely to fall due after the "X-date" - when the government
would exhaust its cash and borrowing capacity. 
    Marciot said he had been taking advantage of a difference in
yields between T-Bills of varying maturities as debt ceiling
jitters had created an unmerited gap between bills that fall due
before and after the expected X-date. For example, in April,
yields on one-month T-bills  US1MT=RR  were as low as 3.34%
while six month bill yields  US6MT=RR  approached 5.1%. 
    "This was very unusual," Marciot said. "So we've been
arbitraging." 
    
    2/ RAINY DAY DEFAULT PROTECTION 
    Credit default swaps (CDS), which work like insurance
against a debt default, are seeing strong demand. 
    Traders most commonly use 6-month CDS, which on Thursday
were trading around 241 basis points (bps), double where they
stood 14 days ago, according to one market participant. 
    "Although a default is highly unlikely, the large potential
pay out in the event of a CDS trigger on a technical default
continues to attract U.S. CDS protection buyers," said Voon Kiat
Lai, senior portfolio manager at Redhedge Asset Management.
    Closing in on the X-date, the risk premium on CDS might
rise, making this protection more valuable and, therefore, more
profitable if sold on to others, he said. 
    
    3/ BUY THE YEN
    Debt ceiling jitters are good timing for the yen, which
slumped 1.6% last week as the Bank of Japan held fast to
ultra-loose monetary policy. The safe-haven yen could be one
beneficiary.
    Nomura currency strategist Yusuke Miyairi said another
reason to expect yen outperformance if wrangling in Washington
escalates is a strong correlation between dollar/yen and
five-year Treasury yields  US5YT=RR .
    "If debt ceiling concerns grow we think markets will price
in more Fed rate cut expectations, which means 5-year yields
would fall," said Miyairi.
    
    4/ STIMULUS: SAVE OR SPLURGE?
    Mikhail Zverev, manager of Edinburgh-based Amati Global
Investors' strategic innovation fund, said that around 15% of
his fund's holdings were companies broadly exposed to spending
related to U.S. President Joe Biden's Inflation Reduction Act, a
stimulus scheme now caught in the crosshairs of debt ceiling
battles.  
    Republican proposals for spending cuts may effect green
investment initiatives signed into law last year. 
    "In equities, anything exposed to government spending will
have a bit of a wobble" as the X-date approaches, Zverev said.
    Zverev's fund owns stocks including Hubbell Incorporated
 HUBB.N , an electricity company, and tech defense contractor
Leonardo DRS  DRS.N .
    
    5/ ALL THAT GLITTERS
    Deutsche Bank strategist Robin Winkler says a good hedge may
be buying gold against the dollar, as it has the tightest
relationship with newsflow around the debt ceiling. 
    Spot gold, seen as a hedge against inflation and banking
turmoil, is trading at around $2,040 per ounce  XAU= , up around
12% so far this year and near record highs. In August 2011, as a
debt ceiling crisis prompted a U.S. credit rating downgrade,
gold rose 11% that month alone.     
    "The best hedge against increasing market concern is
probably to be long gold against the dollar," said Winkler.

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World markets hunker down as US debt ceiling looms    https://tmsnrt.rs/3HEA4Wp
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 (Reporting by Dhara Ranasinghe, Naomi Rovnick, Nell Mackenzie
and Chiara Elisei in London and Davide Barbuscia in New York;
Graphic by Prinz Magtulis; editing by Mark Potter)
 ((Dhara.Ranasinghe@thomsonreuters.com; +442075422684;))