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Interest Rates , Trading

Debt Default: Does It Really Mean Life, Liberty, and … an Ever-rising Dow?

by Robert Folsom
Updated: May 16, 2023

Welcome to Chart of the Day. I'm Robert Folsom.

Debt Default: Does It Really Mean Life, Liberty, and ... an Ever-rising Dow?

"What will you buy if the U.S. hits the debt ceiling?"

This question was recently asked in a survey of professional and retail investors. The top pick among both groups of investors was Gold; and you may think that answer is no surprise, but wait till you hear what was the second-most frequent reply: It was U.S. Treasuries.

Yeah, you heard that right. If the United States defaults on its debt -- as in, it fails to pay the people they owe money -- a significant percentage of investors nevertheless say they will lend ... more money to the government that is in default.

The apparent logic of this is, the U.S. will eventually honor its debt, just later than expected. So to buy Treasuries would be an opportunity to benefit from the likely spike in yields. And, well, that could happen. Yet let's not miss the bigger picture: There's also a rosy-scenario complacency behind this notion, borne of decades of positive mood. Investors believe an inalienable right will activate whereby governments and central banks just sort out the issue.

So, what's this chart and what does it say ... it is, the spread in basis points of U.S. five-year credit default swaps (or CDS). The CDS is a financial derivative that offsets the credit risk investors face of a debt default, in this case default on Treasuries.

Here's where the cost of protecting against default stood in the 2011 crisis, here is where it stands today. Yes, the cost of insurance has spiked dramatically higher.

This chart, and some of what I've explained here come from economist Murray Gunn's daily commentary, via our Interest Rate Pro Service and our monthly Global Market Perspective.

Bonds and interest rates could become volatile indeed in the weeks to come -- yet market volatility is where Elliott wave patterns are the most clear. The near-term forecasts in the Interest Rate Pro Service can keep you a step ahead of the risks and the opportunities, while Global Market Perspective offers longer-term forecasts for major world markets.

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