The Odds of a Near US Debt Default Have More Than Tripled: MSCI

  • The probability of a US debt default has more than tripled since the start of the year, according to MSCI.
  • MSCI said trading activity in US government credit default swaps increased as investors bought insurance against a potentially catastrophic event.
  • A split Congress has just a few months to pass a spending bill to avoid default.

The chances of a catastrophic US debt default have more than tripled since the beginning of the year, according to a recent note from MSCI.

The US debt ceiling was hit in mid-January and since then the US Treasury has taken extraordinary steps to avoid a default and keep the government funded until June.

Now the clock is ticking for a divided Congress to come to an agreement and pass a spending bill to avoid a US debt default, and some investors are worried based on trade activity. of US government credit default swaps of one-year debt.

Credit default swaps are a form of insurance against issuers who do not make their scheduled payments on their debt.

The trading instrument was successfully used by some investors who bet against the housing market in 2008, including Michael Burry of Scion Capital. CDS protection payments are triggered when a loan payment is missed.

“The implied default probabilities have risen to levels not seen since the 2013 debt-ceiling debate,” MSCI said, noting that the probabilities of a debt default rose from 3.3% at the start of January to 11.3%. last week.

While the rise in CDS spreads on US government bonds is fast and large, it is nothing new, as CDS spreads are approaching similar levels seen during the 2011 and 2013 debt-ceiling showdowns. During the battles, Congress reached a last-minute deal to avoid a default.

“In the absence of a legislative agreement, the volume of US government CDS trading may continue to strengthen as summer approaches, and the possibility of missing payments on US Treasurys is greater,” said MSCI.

In the unprecedented event that the US defaults on its debt, the consequences go far beyond treasury holders not receiving their payments.

Such a default could bring the economy to a halt and trigger severe volatility in interest rates, as most global interest rates are in part influenced by the “risk-free” nature of US government debt. In addition, millions of seniors are at risk of losing their social security benefits.

“Major market dislocations and a sharp slowdown in economic activity could both be realistic possibilities” in the event of a US debt default, MSCI said.

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