September 27, 2023

Investors Scramble to Prepare for the Unthinkable

Some debt traders said they were looking for evidence of progress toward a deal before markets open on Monday.

“This press conference was a pretty significant moment,” said Ajay Rajadhyaksha, head of United States fixed-income strategy at Barclays Capital, referring to President Obama’s announcement after markets had closed for the week that talks had broken down. “I would be pretty surprised if investors did not exhibit a greater degree of worry when we walk in Monday morning than they have shown so far.”

Investors also are increasingly worried that even if a deal is reached, the rating agency Standard Poor’s may reconsider its certification of government securities as an ultrasafe investment. The company has said there is a 50 percent chance it will downgrade the rating in the next three months, depending on whether the federal government adopts a long-term plan to pay down its debts. Such a move could send interest rates higher for a broad range of government and consumer loans.

Some of the options still on the table to raise the debt ceiling, involving smaller packages of spending cuts, might not be sufficient to satisfy S. P. or Moody’s and Fitch, two other rating agencies that have expressed concern over the debt negotiations.

“I think the market still has confidence that the debt ceiling will be raised in time,” said Terry Belton, head of fixed-income strategy at JPMorgan Chase. “The focus is on downgrade risk.”

A downgrade would raise the government’s borrowing costs, exacerbating its financial problems, because investors generally demand higher interest rates to hold riskier debt. Consumers and businesses also would face higher borrowing costs because the rates on Treasuries are widely used as a benchmark to set the rates on other kinds of loans.

The government cannot borrow more than $14.3 trillion, the current debt ceiling, a limit that it reached in May. Since then, however, Treasury has continued to repay securities as they come due and issue new debt in their place, a process known as rolling over debt. Officials are concerned that it will become harder to find investors willing to participate in the weekly auctions, and that the remaining buyers will begin to demand higher interest rates.

Over the last few weeks staff members in the Office of Debt Management, a part of the Treasury, have been phoning the desks of the 20 major Wall Street dealers for Treasury bonds to assess investor demand for coming debt auctions, and to seek assurances that the dealers themselves will buy any surplus.

About $87 billion in federal debt comes due on Aug. 4, and roughly $410 billion comes due throughout the rest of August. If interest rates climbed even a tenth of a percentage point, the added cost to roll over the debt would be an extra $500 million a year.

Wall Street is also worried about the effect that a ratings downgrade would have on various assets that are implicitly backed by the federal government, including agency mortgages or municipal bonds.

That, coupled with the myriad problems that failing to raise the debt ceiling could cause, prompted Wall Street’s main lobbying arm, the Securities and Investment Management Association, to organize an advocacy campaign earlier this week. “Urge the administration and Congress to raise the debt ceiling and protect our economy from additional strain,” it said in an e-mail circulated to member firms.

The heightened uncertainty is prompting financial firms and other companies to stockpile cash. Walter Todd of Greenwood Capital, a wealth management firm in Greenwood, S.C., said that so far he had advised his own worried customers not to do the same, operating under the assumption that a deal would be reached. But after the talks fell apart on Friday, Mr. Todd said he and his partners began to discuss a more pessimistic possibility.

“If nothing changes, if the headline out of the weekend is that the talks have broken down, I think you’ll start to see assets reacting to that,” Mr. Todd said. “It blows my mind that it’s come to this. It’s incredibly irresponsible what’s happening, on the part of both sides.”

Other investors said they did not view the opening of markets on Monday as a critical deadline, as they still expected a deal, but that each passing day would put a little more stress on the markets. Bond prices fluctuated last week on the news from Washington, falling Thursday after S. P.’s latest warning, then rising on Friday amid renewed talk that a deal was imminent.

“Every day without an agreement increases the risk of default,” said Ward McCarthy, chief financial economist at Jefferies Company. “Congress likes to go to the edge of the precipice with the debt ceiling, and we are headed toward the edge again.”

Binyamin Appelbaum reported from Washington, and Eric Dash from New York. Louise Story contributed reporting from New York.

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