INSIGHTS

A US DEFAULT RISK PREMIUM?

Ed Peters
|
September 29, 2021

US bond yields have been rising since last week’s Fed meeting. Consensus is that the prospect of the Fed tapering its bond buying program is the culprit. Likely that was true last week. But the prospects of that happening are as likely now as they were a week ago, so why are yields still rising, particularly at the short end of the yield curve? Inflation is an issue, but there has been little news on that front.

Maybe it’s the other bit of ongoing uncertainty. This one is tied to brinksmanship in Washington. There is the threat of a government shutdown. We’ve seen that before, though, and the effect on markets is usually not an issue. The other growing problem is the US debt limit. An initiative to raise the debt limit failed Monday, so the prospects of the US defaulting on its debt have risen. Still not huge, but not trivial either. It’s unlikely to be a coincidence that the short end of the yield curve began rising again at that time, since a default would affect short-term debt first. So it could be that a significant part of the recent rise in US bond yields is a default premium, which we usually only see in corporate bonds or bonds from unstable governments due to their lower quality.

It's something to keep in mind if the debt ceiling standoff doesn’t resolve itself soon.

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