Treasurers Face Default Uncertainty

Exiting Treasuries leaves few investing options; stalemate could stress liquidity.

The possibility that the United States could default on its obligations has created considerable uncertainty for treasurers responsible for short-term corporate investments. And analysts point out that Treasuries and other government securities constitute a huge portion of the investment-grade paper that’s available, leaving investors limited options should they choose to exit the Treasury market.

Lance Pan, director of investment research and strategy at Capital Advisors Group, says that while he views the risk of a U.S. default as “extremely low,” treasurers should be prepared for a stalemate in Washington that could last for weeks, and for the stresses that might place on their company’s liquidity.

“If you have anything coming due between now and the middle of August, try to have some money set aside other than from Treasury bills,” Pan says. “If we were to have a temporary default, which we don’t think will happen, at least you can wait it out. You don’t want to get trapped in the three or four days when you need that money. 

Pan points out that even if the debt-ceiling debate on Capitol Hill continues past the Aug. 2 deadline, the Treasury can still roll over maturing Treasury bills as long as investors continue to buy at the weekly bill auctions. 

An Association for Financial Professionals survey showed that if the debt ceiling weren’t increased on time, almost a quarter of companies that are invested in Treasury securities say they would liquidate some or all of their investments. AFP notes Treasuries are one of the three most popular investment vehicles for companies, along with bank deposits and money market funds. 

There’s also the possibility that U.S. debt will be downgraded even if the country doesn’t default. Pan says that if a company’s guidelines restrict it to investing in Triple-A securities, it might want to sell now rather than trying to unload securities amid what would likely be less favorable market conditions in the wake of a downgrade. 

But he notes that most corporate investment policies don’t specify a rating for government securities, only for corporates. If that’s the case, Pan says, companies don’t have to do anything as long as Treasuries remain investment grade. Of course, a U.S. downgrade would affect not only Treasuries, but related securities, like the debt of government-sponsored entities like Fannie Mae and Freddie Mac, and many municipal bonds, and investors need to take that into account.

There’s also the issue of the possible impact on money market funds. Earlier this week, Moody’s said the uncertainty about the U.S. debt ceiling was raising risks for money funds. The rating agency cited the potential for missed interest or principal payments on U.S. debt and increased market volatility that could lead to a pick-up in redemptions that would put pressure on funds’ liquidity.

Pan says money funds are bracing themselves, in part by shortening the maturity of their holdings, but adds that he expects the Fed to step in to help with funding if problems emerge.

Pan says most of his clients could live with double-A-rated Treasuries. His clients generally invest in U.S.-dollar-denominated debt, he adds, “and there are very limited options for them to explore outside the U.S. government sector.”

Steve Johnson, chief investment officer at DB Advisors, a unit of Deutsche Bank, also cited the limited stock of high quality, extremely liquid securities outside of the U.S. government market.

“Fixed-income investors have to deal with the reality that there aren’t that many things that are always liquid and offered in the fixed-income markets,” Johnson said on a conference call Tuesday. “If the U.S. were downgraded, the stock of Triple-A debt would probably fall in half—Treasuries and agencies probably represent more than half of the Triple-A debt offered to global investors. So your options become much more limited.”

Johnson said that while a U.S. downgrade might violate credit quality restraints in the guidelines of institutional fixed-income investors, he thought in most cases investors would focus on reworking their guidelines. And he argued that those investors who did decide to make changes in their portfolio would be more likely to sell lower-rated securities than Treasuries.

“I don’t think any holder of U.S. debt is worried about not getting paid back,” Josh Feinman, global chief economist at DB Advisors, said on the conference call Tuesday. “Even if rating agency downgrades the U.S., I don’t think people are going to shift their view of U.S. debt.”

But Pan argues that if the U.S. credit rating is downgraded, the costs could be quite high. “We have been able to have a very affordable funding market in the U.S., and that may not remain if the country is permanently downgraded,” he says.

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