Investors keep eyes peeled on central bank rate moves
US Treasuries shrugged off the debt-ceiling agreement reached by lawmakers this week, as Wall Street focused on policy decisions by two of the world’s most important central banks in the coming days.
Following the announcement that the White House had struck a bipartisan two-year deal to raise federal spending and the country’s borrowing limit, yields on short-term Treasury bills fell before quickly rebounding. Ten-year Treasuries barely budged as well, with yields steady at 2.05 per cent.
The later large jump in 10-year Treasury yields came only as it was reported that Robert Lighthizer, the US trade representative, and other senior US officials are preparing to travel to Beijing to hold high-level discussions with their Chinese counterparts in what may be the first step towards some kind of trade resolution.
Just eight years ago, the same debt-ceiling debate threw Treasury markets into turmoil after lawmakers just barely met the deadline to avoid a debt default.
Congressional leaders eschewed brinkmanship this time round, instead scrambling early on to negotiate a compromise more than a month before the September deadline by which Steven Mnuchin, Treasury secretary, warned the US government would be at risk of not being able to pay its bills.
“There is no political will to actually cut spending or contain the deficit, so markets didn’t view the debt ceiling as a significant tail risk,” said Priya Misra at TD Securities.
According to calculations crunched by Capital Economics, the federal budget is set to exceed $1tn next year. Within 10 years, the firm forecasts US federal debt to exceed 100 per cent of gross domestic product.
Moreover, financial markets are more preoccupied with the looming interest rate decisions by the European Central Bank and the US Federal Reserve due this week and next.
The ECB is set to meet on Thursday, less than a week before the Fed is scheduled to convene. Expectations for respective rate cuts by the central banks have bounced around a bit in recent days, indicating just how uncertain market participants are about the future path of interest rates.
Markets are currently pricing in a 37 per cent chance the ECB will cut its benchmark interest rate by 10 basis points on Thursday. In the US, traders see an 83 per cent chance of a 25bp cut next week.
“Raising the debt ceiling is on the checklist to avoid disaster, but at the end of the day, the number one factor for yields is what the trajectory of central banks will be,” said Guy LeBas, chief fixed-income strategist at Janney Capital Management.
For Jon Hill at BMO Capital Markets, the debt-ceiling deal cleared “a technical annoyance and small tail-risk for the global economy”, but given the ongoing US-China trade war, the stalemate of Britain’s exit from the EU and global growth concerns, “the underlying macroeconomic situation hasn’t changed”.
But Treasury markets would not remain completely unaffected by the eventual passage of the debt-ceiling deal into law, argued Ms Misra at TD Securities. In fact, there could be $250bn-$300bn in short-term Treasury bill issuance as a result over the next two months, putting downward pressure on prices.
“The default risk in the Treasury bills is being replaced by supply risk,” she said.