INVESTORS have remained remarkably sanguine, despite being just a couple of days from the 17 October date when the US Treasury says it will run out of money if the debt ceiling isn’t raised. Yes, volatility has spiked, and very short-dated credit has seen yields higher. But whatever last minute extension is crafted, everyone expects a deal.
How long this stay of execution lasts is another matter. We could be back here again shortly, but the fundamental belief is that the US government will not default on its debt. Even in the worst case scenario, there are those – like Roger Bootle of Capital Economics – who believe the Treasury would plead the fourteenth amendment to the Constitution. This states that the “validity of the public debt of the United States...shall not be questioned”. Theoretically, the Treasury could keep meeting its commitments with this as a defence, though the legal wrangle would run for years.
But this episode does show the increasingly dysfunctional nature of US politics. It’s quite extraordinary when US politicians can make their Italian counterparts seem like statesmen. But somehow, after the Italian Senate decided not to commit hari kari by collapsing the Letta coalition this month, that’s what happened. Not that Italy is anywhere near out of the woods, either, with votes on electoral laws still to come.
This brings us to another interesting market dynamic. Politically speaking, many emerging markets are paragons of stability and responsibility compared to the US and Italy, two of the world’s three biggest government debt markets. Yet investors are more concerned about the likes of India and Turkey.
A few days ago, Spain sold its first 30 year bond since 2009, with a yield of 5.2 per cent. This matched the country’s three-month borrowing costs at the height of the Eurozone crisis. Two thirds of the demand came from foreigners, while at the same time emerging market bond funds, according to EPFR Global, suffered $560m (£349m) in outflows for the week ending 9 October.
Yes, emerging markets suffered greatly from the Fed taper trade. But it appears that – whatever the politics – investors are still prepared to bet on the improving economic prospects of developed countries, compared to deterioration in the emerging world. Providing US default really is off the table, that will continue and none more so than for equity players. Aided by low rates, companies in Europe and America continue to issue debt cheaper than the rates they have to pay on dividends. This makes it pretty simple to borrow and buy back stock.
Ross Westgate co-presents CNBC’s Worldwide Exchange. @rosswestgate