Some large institutional investors may not be able to hold bonds that are in default, so they could be forced to unload their massive holdings.
analysts see a large-scale forced selling of Treasuries as a relatively low risk, however.
“Many investment mandates allow investment in Treasury debt or sovereign debt generally, without regard to the rating of that debt, so a downgrade should not generally affect the ability of major holders to continue holding securities,” Goldman analysts said in an Oct. 5 note.
The bigger concern may be an exodus from money-market funds, which often trade in short-term Treasury bonds. Investors worry that defaulted Treasuries could prompt money-market funds to sell.
What would happen to the United States’ credit rating and its borrowing costs?
In other words, a default could exacerbate the U.S. debt.
The immediate impact to the U.S. could be higher borrowing costs to fund government operations, because investors would demand higher interest payments to compensate them for newly demonstrated risk. A U.S. default would presumably lead to downgrade by credit ratings firms. Standard & Poor’s downgraded the U.S. credit rating two years ago during the last furor over the debt ceiling.
A downgrade could also affect bonds issued by other government agencies at the state and local level.
Kenneth Bentsen Jr., president of the Securities Industry and Financial Markets Assn., a Wall Street trade group, told Congress last week a default would “trigger a series of events which inevitably would lead to American taxpayers paying more to finance our debt” and could imperil “our fragile economic recovery.”
What kind of market turmoil might we see?
When the U.S. last flirted with a default two years, the stock market fell into a 17% correction. The Dow Jones industrial average sank 634 points on the day that S&P issued its downgrade.
Some worry about a credit crunch, particularly in short-term financing.
Already, there are signs of anxiety growing in a corner of the financial world known as the repo market. Repo is short for repurchase agreement, and this corner of finance allows companies to pay for short-term capital needs. U.S. Treasury bonds are often used as collateral.
Last week, yields on one-month U.S. Treasury bonds jumped as investors grew nervous about whether the government would meet its looming obligations.
Yields, a measure of perceived risk, jumped to 0.33% Tuesday, more than double the 0.16% the previous day. One-month Treasury yields have retreated but remain elevated around 0.24% as of early Tuesday.
Yields on three- and six-month Treasury bonds, meanwhile, jumped Tuesday as dealmakers in Washington considered a deal that would raise the debt ceiling for six weeks, according to Tradeweb.
In the case of default, rising interest rates could bleed into rates paid by consumers, such as for mortgages.
Where would investors flee for safety?
When the U.S. credit rating was downgraded, investors nonetheless plowed into Treasury bonds, pushing down the country’s borrowing costs. But this time Europe is no longer in recession. And if the U.S. defaulted, Treasuries may no longer be such a safe haven.
Investors might instead favor bonds issued by other countries with similarly strong credit ratings, analysts said. Or they could pile into bank accounts that are insured by the
Federal Deposit Insurance Corp.
