Many people depend on Treasuries for income. People depend on the money from interest or principal payments of treasuries to show up in their accounts so that they can spend money as planned. Treasuries are perfect for tight tolerance, high dependency financial situations. Money is disbursed via the FedWire system which, in my experience, can put money in your account within minutes. That the Treasury United States of America will pay its debts on time has been a reliable fact for a long time now.
For many holders of Treasuries, a little delay in getting their money wouldn't be such a big deal. Getting paid on Tuesday instead of Monday or the previous Friday wouldn't affect my cash flow terribly. However, there are holders who depend on timing of payments much more than I do.
One of the largest uses of Treasuries in the financial world is called the RePo market - overnight lending. Banks let each other borrow Treasuries for a very short term (often overnight) in exchange for cash. Since Treasuries are a sure thing, nobody has anything to worry about. Treasuries are perfect loan collateral.
But the United States is dangerously close to defaulting on its payments. If this occurs, it will more likely be an interruption to the market than a 'real' default. There are, however, billions of dollars of payments riding on the timely payment of Treasury debt. On top of that, probably trillions of dollars of derivatives are priced based on Treasury rates. Large banks depend on huge sums of money changing hands all of the time, this interruption will be an immediate credit crisis for banks.
There may be some options for Treasury holders, and some may be able to cope with a delay in payments, but there will be some holders who get put in an extremely tight spot. Whether they have real cash needs that were meant to be funded with that, and cannot pay bills (including their own debts) or have a line of credit that's interest payment spikes due to the crisis, they will be pinched between a Treasury unable to pay them and customers demanding payment.
It is annoying to have your paycheck delayed by a day or so, it is disastrous to have your paycheck delayed when you have a major purchase to make on that day.
Independent, Fee-Only Financial Advisor
Tuesday, October 15, 2013
default and consequences
In the financial world, it is unthinkable that America would default on it's debt obligation. Thats why in 2011 when we were on the edge of hitting the debt limit, treasuries rose in price! The cost of going into debt got cheaper, not more expensive, when we almost defaulted! Let's be clear, nobody really thinks that a "real" default will happen, but still serious is the risk that payments get interrupted for any amount of time.
Since it is fairly unthinkable that America would default, treasuries are used in several very big important ways. Firstly, yields on treasuries are considered the "risk free rate" in economic and financial models worldwide, and are used in setting the prices of many financial tools such as derivatives. Derivatives are used by banks and large companies to manage their financial transactions, lock in prices, or prevent losses beyond a certain point.
As treasuries are so important, it is hard to come up with alternatives. Because of that lack of creativity, a default might not have a terrible impact on the treasury market. What else can banks trade in such large quantities so easily? The short term impact might be minimal, but over the long term, risk of default, or interruption would be priced into bonds, raising the yield for the buyer, but increasing the cost of financing for the seller.
If people see rates rising, that means bond positions will certainly be money losers. Pulling money out of bonds leaves pretty much two places to put them - stocks or cash. That could be a plus for the stock market, and cash getting spent would be a plus for the economy. Higher financing cost would eat into the record high corporate profit margins right now and mess with stock valuations if there is not an accompanying rise in revenue.
Those are some portfolio impacts of a default. Next post I will look at the most frightening immediate economic consequence...
Since it is fairly unthinkable that America would default, treasuries are used in several very big important ways. Firstly, yields on treasuries are considered the "risk free rate" in economic and financial models worldwide, and are used in setting the prices of many financial tools such as derivatives. Derivatives are used by banks and large companies to manage their financial transactions, lock in prices, or prevent losses beyond a certain point.
As treasuries are so important, it is hard to come up with alternatives. Because of that lack of creativity, a default might not have a terrible impact on the treasury market. What else can banks trade in such large quantities so easily? The short term impact might be minimal, but over the long term, risk of default, or interruption would be priced into bonds, raising the yield for the buyer, but increasing the cost of financing for the seller.
If people see rates rising, that means bond positions will certainly be money losers. Pulling money out of bonds leaves pretty much two places to put them - stocks or cash. That could be a plus for the stock market, and cash getting spent would be a plus for the economy. Higher financing cost would eat into the record high corporate profit margins right now and mess with stock valuations if there is not an accompanying rise in revenue.
Those are some portfolio impacts of a default. Next post I will look at the most frightening immediate economic consequence...
Thursday, October 10, 2013
Give 'em Hell, Barry
A contingent of Republicans headed to Pennsylvania Avenue for a meeting with the President. They left without speaking to the press. They avoided ANY conversation. They headed back to Capitol Hill in absolute silence.
Word is that Obama said, "No negotiation unless they reopen the government." Hmm...
Markets celebrated a potential break in the impasse today. Those green numbers could disappear with this latest development. Stock futures are pointing to a rough day tomorrow. Rumors are circulating of a sell-off in the bond market. When all confidence is lost in Treasury bonds, what else is there?
All I know to do is light a few candles, pray for world peace, and hope good sense returns to all parties. This latest development will be the break in the dam that either brings us blessed relief or drowns us all.
Systematic risk is not for faint-hearted.
Word is that Obama said, "No negotiation unless they reopen the government." Hmm...
Markets celebrated a potential break in the impasse today. Those green numbers could disappear with this latest development. Stock futures are pointing to a rough day tomorrow. Rumors are circulating of a sell-off in the bond market. When all confidence is lost in Treasury bonds, what else is there?
All I know to do is light a few candles, pray for world peace, and hope good sense returns to all parties. This latest development will be the break in the dam that either brings us blessed relief or drowns us all.
Systematic risk is not for faint-hearted.
Tuesday, October 08, 2013
Shutdown Winners
We're still in shutdown mode. As the latest created crisis continues, investors weigh the damage and look for opportunity.
The US is the largest economy on the planet (for now), and all eyes look to us for guidance. With the chaos in Washington, other leaders across the globe wonder if they should continue to follow our lead-- no, I meant example.
As this fight drags on, there is the very real possibility of the US sliding back into recession. According to the equation, GDP comes from 4 inputs: 1) capital investment, 2) net exports, 3) government spending, and 4) consumer spending. The biggest contributor to our economic growth is number 4. When we spend, business does well, the economy grows-- and round and round we go. Consumer spending accounts for about 2/3 of GDP.
While government spending accounts for a smaller percentage of our economy, it is a crucial part. Economists are now measuring the "dings" to GDP of this shutdown on a daily basis. Bigger than that, though, is the damage to consumer confidence.
Consumer confidence is the grease of our economic engine. When we see the mess each day on the news, we worry. We get concerned about our jobs and our personal economic situation. We pull back on spending.
The damage is easier to see than the possible opportunity. As this crisis drags on, the dollar slips. And other currencies rally. We know the largest portion of the return on international investments comes from the currency differences. The first part of the year, emerging markets dragged everything down. The dollar was strengthening then.
May be time to go all in with emerging?
The US is the largest economy on the planet (for now), and all eyes look to us for guidance. With the chaos in Washington, other leaders across the globe wonder if they should continue to follow our lead-- no, I meant example.
As this fight drags on, there is the very real possibility of the US sliding back into recession. According to the equation, GDP comes from 4 inputs: 1) capital investment, 2) net exports, 3) government spending, and 4) consumer spending. The biggest contributor to our economic growth is number 4. When we spend, business does well, the economy grows-- and round and round we go. Consumer spending accounts for about 2/3 of GDP.
While government spending accounts for a smaller percentage of our economy, it is a crucial part. Economists are now measuring the "dings" to GDP of this shutdown on a daily basis. Bigger than that, though, is the damage to consumer confidence.
Consumer confidence is the grease of our economic engine. When we see the mess each day on the news, we worry. We get concerned about our jobs and our personal economic situation. We pull back on spending.
The damage is easier to see than the possible opportunity. As this crisis drags on, the dollar slips. And other currencies rally. We know the largest portion of the return on international investments comes from the currency differences. The first part of the year, emerging markets dragged everything down. The dollar was strengthening then.
May be time to go all in with emerging?
Tuesday, October 01, 2013
Congress is Breaking Bad
So my hound dog, Loretta, woke me up at 5:30 this morning. As we brewed our morning coffee, my husband said, "Do you think we're shut down?" My response? "Without a doubt." With that, we retired to our warm bed and cranked up Netflix.
Congress appears badly broken, and we just couldn't bear another hour of analysis and hand-wringing. We're in season 3 of the popular show, Breaking Bad, and it seemed a better use of our time to watch fictional criminals and their antics versus watching the real thing. We decided to forego morning TV.
On Monday, the stock market dropped significantly in anticipation of the deadline. Investors already knew what DC was going to do. The shutdown was written in each index in red ink. On Tuesday, markets headed back to green once the inevitable happened.
The length of the stalemate will determine the damage to this quarter's GDP. Of course, we may not even know what the GDP is if we can't get the statisticians back to work! Friday is the day for monthly jobs numbers-- a much anticipated event. After watching the trend in weekly numbers, we were certain they would be good. That piece of data may remain a mystery.
In the long-run, the market will brush off the latest fight in Washington. Business is business, and things will move on. But in the short-run, the crazy play-by-play in Congress will result in plot twists and turns for investors.
I think I'll avoid all news until the whole thing is over-- maybe sometime next Spring. By then, I should be in the final season of Breaking Bad. Better to be entertained by scary criminals than scared to death by the entertaining clowns in Congress!
Congress appears badly broken, and we just couldn't bear another hour of analysis and hand-wringing. We're in season 3 of the popular show, Breaking Bad, and it seemed a better use of our time to watch fictional criminals and their antics versus watching the real thing. We decided to forego morning TV.
On Monday, the stock market dropped significantly in anticipation of the deadline. Investors already knew what DC was going to do. The shutdown was written in each index in red ink. On Tuesday, markets headed back to green once the inevitable happened.
The length of the stalemate will determine the damage to this quarter's GDP. Of course, we may not even know what the GDP is if we can't get the statisticians back to work! Friday is the day for monthly jobs numbers-- a much anticipated event. After watching the trend in weekly numbers, we were certain they would be good. That piece of data may remain a mystery.
In the long-run, the market will brush off the latest fight in Washington. Business is business, and things will move on. But in the short-run, the crazy play-by-play in Congress will result in plot twists and turns for investors.
I think I'll avoid all news until the whole thing is over-- maybe sometime next Spring. By then, I should be in the final season of Breaking Bad. Better to be entertained by scary criminals than scared to death by the entertaining clowns in Congress!
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