The potential upcoming default of the U.S. debt has led to a conundrum for bond and stock traders. I see them pushed into a corner with their backs against the wall.
For the longest time I have been frustrated by the "flight to safety" trade. Every time we have had a risk event (financial crisis of 2008, near default in 2011 — just to name a few) we have seen traders buy U.S. dollars and U.S. bonds in bucket loads. The fact that we have a crisis in the United States, with deficits spiraling out of control, the debt default has never stopped the trader from rushing to safety of the U.S. dollar and U.S. Treasurys.
Will it be different this time?
Let's take stock of what is happening so far:
The passing of the 2014 budget for the United States has stalled. There is an actual shutdown of the process, which has furloughed over a million people and the ranks of unemployed are growing. Now was it not the job of both parties to do what is best for the masses, reduce unemployment and give everyone hope? The shocking part is that the cause of the delay in approving the budget is not what's in it, but rather the two parties not cooperating with each other on healthcare.
Average citizens who have hired the congressmen are suffering. The masses are frustrated that they are suffering, while tantrums are being thrown by each party. One small wing of the Republicans is holding the country hostage, while the rest of the Republican Party is not behind even their own faction. Yet the shutdown continues with no end in sight.
We are now eight days away from the debt default. The two parties do not seem to care whether they drag the possible historical default of the U.S. government debt, the pillar of all confidence in the financial world and the epitome of safety, down with them in the bickering they are engaged in.
If the United States does default on its debt obligations, there will be significant consequences. The largest holders of our debt, China and Japan, who are already exasperated by our antics, may refuse to buy more debt or actually even sell our debt. While we may act cavalier and suggest that the Federal Reserve buy even more of the U.S. debt, it only digs the hole deeper that the Feds will have to climb out of. With no potential buyers of our debt, if we default, we will take the Fed down with us. That will fold this house of cards that has been constructed.
So what is the "flight to safety" trade now? I would be hard pressed to believe that the safe trade is to buy more U.S. dollars and more U.S. Treasurys and debt when that is the one about to default.
Who in their right minds would buy debt that is just about to default? Who would think buying U.S. dollars is the rush to safety when the country is about to default, has a government that is shut down for weeks and will see a dramatic decline in the already fragile economy?
If this does not force you to sell U.S. dollars and diversify in to less risky assets, what will?
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