There's a divide in how traders are prepping for a debt-ceiling showdown – Business Insider

This post was originally published on this site

Bond and stock traders are showing different levels of anxiety about the US government’s ability to keep itself funded. 

Congress is expected to pass a bill by the end of September to keep the government funded, or it risks a shutdown of nonessential functions. It also needs to raise the debt ceiling by early October to prevent a potential default.

For now, stocks — or at least a measure of volatility expectations — reflect a more sanguine outlook for September and October. Rates traders, meanwhile, are shunning Treasury bills that mature around the same time.

First, let’s look at the stock market 

Mandy Xu, a derivatives strategist at Credit Suisse, examined the implied-volatility term structure for the S&P 500 (or SPX) a measure derived from options data.

Although the term-structure curve is upwards sloping — meaning traders anticipate some increase in volatility — there’s no obvious kink around October. 

“Despite a heavy upcoming macro calendar (Fed meeting, debt ceiling, budget deadline, etc), S&P volatility surface is still not pricing in any event risk for September/October, with the term structure uniformly upward sloping and absolute levels of vols near historic lows,” she wrote in a note to clients. That lack of an event risk can be seen in this chart.

9 6 17 stocks debt ceiling COTDCredit Suisse

There are a number of other things that equity traders could pick to be worried about, such as geopolitical tensions with North Korea. But the continued low levels of volatility show that there’s more focus on long-term drivers. 

“Our long standing thesis has been that the current rally has not been driven by expectations of policy change,” said Binky Chadha, the chief strategist at Deutsche Bank, in a recent note. He continued: “The S&P 500’s typical trajectory around domestic political and geopolitical events historically has been of sharp short-lived sell-offs with the economic context eventually dominating.” 

Bonds are sending a different signal 

Rates traders appear to have less faith than stock traders that Congress will be able to pass legislation on time. On Tuesday, a $20 billion auction for 4-week Treasury bills, which expire just after the debt ceiling could be hit on September, drew the highest yield since 2008, indicating much less demand for them.

The auction results, which one strategist described as ghastly, indicate bond traders are demanding a premium for the bills that will have to be repaid just as the government is hitting its limits. If they shared the stock markets faith that this will be a non-event, they presumably wouldn’t ask to be paid more.

Also, the yields on existing bills that mature in early October are higher than those in the months afterwards, even though traders typically want a higher premium for holding onto bonds for longer. treasury yields by maturity 9 6 17Andy Kiersz/Business Insider