Chances of a catastrophic US debt default have tripled in 2 months

The odds of a catastrophic default on US government debt have more than tripled since the start of the year, according to a recent note from MSCI.

Recall that the US debt ceiling was reached in mid-January and, since then, “the Treasury has taken extraordinary measures to avoid default and maintain state financing until June,” Business Insider said.

“Now, the clock is ticking for a divided Congress to accept a spending bill that will prevent a default on U.S. debt, and some investors are growing concerned about swap trading activity on credit default (CDS) on the US public market for one-year debt,” it was explained.

“Credit default swaps are a form of insurance against default by issuers,” he explained.

A credit default swap is default insurance with a market price. The higher the demand, the higher the value of the insurance and vice versa. The probability of default implied in this value is not a direct or accurate prediction of default risk. Rather, it is a calculation of how likely a default should be, in this case on US bonds, for the market price to be justified. In other words, how likely should a default be to justify the price paid to cover that eventuality.

“This trading instrument has been successfully used by some investors who bet against the real estate market in 2008, including Michael Bury, from Scion Capital. CDS protection payments kick in when you fail to repay a debt,” Business Insider explained.

“Implied default ratings have reached levels not seen since the 2013 debt ceiling debate,” MSCI said, noting that default ratings jumped 3.3% in early January to 11.3. % up to last week.

“While the rise in CDS spreads on US government bonds has been rapid and massive, it is not unprecedented, as CDS spreads are approaching levels similar to those seen during the debt cap debates. debt of 2011 and 2013. During these battles, Congress reached a last-minute agreement to avoid a default,” he recalled, referring to the difficult years following the global financial crisis.

“Absent a legislative agreement, US government CDS trading volume may continue to strengthen as summer approaches, and the possibility of a US Treasury default looms,” he said. said MSCI in a note.

“In the unprecedented event that the United States defaults on its debt, the consequences go far beyond Treasury bondholders not receiving their payments,” he warned.

“Such a default could cripple the economy and lead to extreme interest rate volatility, as much of the world’s interest rate levels are influenced in part by the ‘riskless’ nature of government debt. American,” he said.

In addition, “millions of elderly people would risk losing their social security benefits”.

“According to MSCI, in the event of a US debt default, major market dislocation and a sharp slowdown in economic activity would be possible,” Business Insider noted.

A chart from the MSCI report shows that while US CDS have risen sharply since January, those of China, Mexico and Brazil have remained stable. Clearly, the global economy still does not see the real risk involved in a default by the world’s largest economy.

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