TOPICS > Economy

How Would Raising Debt Ceiling Impact U.S. Bond Market?

April 13, 2011 at 6:23 PM EDT
As part of his series on Making Sen$e of financial news, economics correspondent Paul Solman reports on how raising the debt ceiling again would affect the U.S. bond market.
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GWEN IFILL: As we have just heard from Secretary Geithner, the administration is also preparing to do battle over whether to raise the nation’s debt ceiling.

NewsHour economics correspondent Paul Solman looks at why investors and the markets are keeping an eye on the potential impact of that battle as well.

It’s part of his ongoing reporting on Making Sense of financial news.

PAUL SOLMAN: It’s not just the Obama administration worrying about whether the debt ceiling will be raised this spring. Fed Chairman Ben Bernanke has joined the chorus.

BEN BERNANKE, Federal Reserve chairman: The United States would be forced into a position of defaulting on its debt. And the implications of that for our financial system, for our fiscal policy, for our economy would be catastrophic.

PAUL SOLMAN: The dire warnings raise a host of questions. For one, who would spark the catastrophe? Answer: the supposedly trigger-happy investors known these days as the bond vigilantes, though they might call themselves Paul Reveres.

ACTOR: Nothing is worth this price.

PAUL SOLMAN: These are holders of U.S. government debt, our bonds.

ACTOR: We’re going to show you how much we are willing to pay.

PAUL SOLMAN: The fear is that, if we don’t cut our deficits, they would dump the bonds in a fire sale, as economist Nouriel Roubini warned us last year.

NOURIEL ROUBINI, NYU Stern School of Business: The bond market vigilantes have already woken up in Greece, in Portugal, in Spain, U.K., in Ireland, Iceland, but soon enough, they’re going to wake up in the United States.

PAUL SOLMAN: Wake up and suddenly demand higher rates to keep lending America money, and thus raise our cost of borrowing, which would lead us to higher government deficits and thus even more borrowing.

So last week, the budget impasse at its climax, we had gone to the bond trading floor of Nomura Securities in New York for good footage of the stampeding vigilantes.

JOSEPH MARRA, Nomura Securities: You’re not going to find any. No vigilantes here.

PAUL SOLMAN: What we would find, said Joseph Marra, who runs the fixed-income desk here, lots of colorful computer screens tracking the interest rate the U.S. has to pay when it borrows, in this case, for a five-year loan.

Ah. So this is how much the U.S. has to pay in interest in order to borrow money for five years.

JOSEPH MARRA: Correct. It shows that yields basically, over the course of the year, in five-year notes, have gone from something like 2.75 percent all the way down to 1 percent, and then they bounced now close to where they’re back up, you know, around 2.30.

PAUL SOLMAN: But 2.30 — an interest rate of 2.30 percent — is historically rock bottom. Here are rates for the past 50 years. There’s the recent rise.

So, what’s kept rates so low for so long? Huge investors, Japan and China especially, which have so long found U.S. bonds the safest place to store their growing wealth — not exactly vigilante behavior.

JOSEPH MARRA: Clearly, when you — Chinese and Japanese are massive investors in the treasury market. By no stretch can you say that they are vigilantes.

PAUL SOLMAN: Indeed, even recently, troubles elsewhere in the world have prompted them and pretty much all other investors to want safe U.S. dollar investments: our bonds.

JOSEPH MARRA: I don’t want to say it was the only game in town last year, but if you were a big institutional buyer, a central bank, a global bank, you know, it — it benefited greatly from that backdrop of Europe debt markets in crisis and a global economy that was still fundamentally not quite sound.

PAUL SOLMAN: So, you could look at that as a flight to safety or a flight away from the un-safety of Europe.

JOSEPH MARRA: Absolutely.

PAUL SOLMAN: Republican economist Douglas Holtz-Eakin said recently, I’m told, the United States is the best horse in the glue factory.

GEORGE GONCALVES, Nomura Securities: I think there is some merit to that — to that statement.

PAUL SOLMAN: Nomura Strategist George Goncalves:

GEORGE GONCALVES: There’s a consistent buying from the foreign crowd that keeps our rates in check.

PAUL SOLMAN: But, if further debt cuts can’t be agreed to and the U.S. looks like it will hit its debt ceiling?

GEORGE GONCALVES: Then there could be some uncertainty that is embedded into the bond market, which might cause yields to rise.

And so, in other words, either foreign investors or domestic investors might feel concern about what’s happening down in D.C. and start to charge a premium to buy securities.

PAUL SOLMAN: House Speaker John Boehner puts it bluntly.

REP. JOHN BOEHNER, R-Ohio, speaker of the House: We do not want to default on our debt. We shouldn’t default on our debt. These are obligations of the federal government. Not raising the debt limit would have very serious implications for the worldwide economy and jobs here in America.

But, having said that, we’re just not going to do the typical Washington thing, roll over, increase the debt limit, without addressing the underlying problem.

PAUL SOLMAN: And if the limit isn’t increased?

JAMIE DIMON, J.P. Morgan Chase: Now, here’s what really would happen.

PAUL SOLMAN: J.P. Morgan CEO Jamie Dimon:

JAMIE DIMON: Every single company with treasuries, every insurance fund, every — every requirement that — it will start snowballing. Automatic, you don’t pay your debt, there will be default by ratings agencies. All short-term financing will disappear. I would have hundreds of work streams working around the world protecting our company for that kind of event.

PAUL SOLMAN: In other words, selling the U.S. bonds already out there in the market, forcing the government to hike its interest rate offer to get investors to make new loans, that is to buy new bonds.

But if J.P. Morgan is going to sell tomorrow, Pimco, the world’s largest bond fund, figured it made sense to sell yesterday. Pimco cleared its portfolio of U.S. bonds back in January.

In an article earlier this month, CEO Bill Gross compared Congress to the cartoon character Pepe Le Pew. “Citizens of America, hold your noses,” wrote Gross. “You ain’t smelled nothing yet.”

And according to Nomura strategist Jens Nordvig, there are some ominous signs on the foreign exchange desk as well.

JENS NORDVIG, Nomura Securities: If you look at the euro, if you look at the Australian dollar, the British pound, the dollar has been significantly weaker against all those currencies over the last couple of months.

PAUL SOLMAN: A simple question then: Why?

JENS NORDVIG: There’s two reasons, I think. First of all, U.S. growth is kind of not really doing much, whereas growth in the rest of the world has been improving. So that’s been number one.

But I do think this fiscal concern is sort of in the back of investors’ heads, something that makes them a bit uneasy. It’s often the case that the currency market reacts before other markets. And I think this is an example of that.

PAUL SOLMAN: But for the moment at least, the bond market has been quiet as a dormouse. And here’s why, says Nomura’s chief economist, David Resler.

DAVID RESLER, Nomura Securities: I think there’s a lot more reason for optimism that there will be something done on the long-run budget deficit than there was a year-and-a-half ago.

PAUL SOLMAN: So, the traditional fear about the bond vigilantes doing something drastic has been allayed in your mind because we’re now actually talking about doing something?

DAVID RESLER: The bond vigilantes have had to carry the heavy water of watching the government and what it does to make sure that those actions are accurately reflected in financial markets. Now we have got a much broader-based vigilantism that’s going on. We have a lot more eyeballs watching this problem.

PAUL SOLMAN: Not just the bond vigilantes.

DAVID RESLER: Not just the bond vigilantes. You and I are watching it.

PAUL SOLMAN: And as we watch, the pressure on debt-cutting continues, for better or worse.

GWEN IFILL: And a correction to Paul’s story: John Boehner is, of course, the speaker of the House, not the majority leader. (Editor’s note: The transcript has been changed to reflect this correction.)