One would think that the debt ceiling debate would be a key issue for the bond market considering Treasuries are sort of the definitive US government debt. One would also be wholly mislead by hearkening back to the massive market movement in 2011 as evidence that bonds care deeply about a debt ceiling debate.
As we couldn’t shut up about at the time, the big market movement was almost exclusively due to the burgeoning EU debt crisis. Debt ceiling headlines just happened to be in the right place at the right time when the rest of the world was legitimately panicking over a systemic collapse of the Euro that promised to set the financial system back decades and cause fallout that may have made the financial crisis seem mild in many ways.
We put together some fairly noisy charts of various EU countries’ sovereign debt spreads vs Germany at the time. The higher the line, the greater the fear/panic/concern/etc. Here is the unscaled version which places the focus on Greece:
But the most interesting part of that chart is actually the sharp uptick in Spain/Italy credit spreads. Ireland was also entering the 2nd phase of a big surge that began in late 2010. All of that drama was going down in late July and early August. Here’s a scaled version that allows a slightly better view of the relative movement:
It was at this time that the groundwork was being laid for what would eventually be European QE, even though it wouldn’t become official until the end of 2014. Here’s an article snippet we posted on August 4th, 2011:
2:57PM : Investors Snub ECB Liquidity Promises.
(Reuters) – The Italian government bond yield premium over Bunds rose to euro era peaks on Thursday on signs the European Central Bank had no immediate plans of buying Italian and Spanish bonds to arrest a worsening sovereign debt crisis. The ECB said after leaving interest rates unchanged at 1.5 percent that it would broaden its liquidity operations as it revived its bond buying programme in the secondary market by purchasing Portuguse and Irish bonds. A euro zone monetary source said ECB bond purchases in the secondary market would be confined to those countries, fueling worries that the debt crisis would sweep Italy and Spain into its vortex. “The SMP is back but it’s not in the right places, what’s going to stop us attacking Spain and Italy over the summer months, cause I can’t think of anything,” said a trader in London. “There is no buying of Italy and Spain going on and there won’t be, so why can’t we push these markets to 7 percent yields, I think we can quite easily,” the trader said. The 10-year Italian/German bond yield spread widened to 392 basis points, the most since the launch of the euro in 1999 while the equivalent Spanish spread expanded to 400 bps from 386 bps at Wednesday’s settlement.
Long story short, the world’s biggest central banks showed markets that they could be pushed into coughing up more and more money, so the market set about extracting that money. A cynic might call this targeted extortion while other might simply say the market was too unwilling to take risk without central banks standing by as a backstop.
Bottom line, THAT stuff back then was super interesting and highly consequential. The debt ceiling was a sideshow with limited lasting implications for the global economy (default would be a different story, but let’s cross that unlikely bridge on the 0.001% chance we come to it). If the debt ceiling gets a headline these today, it’s because there is relatively little at which to shake sticks for the remainder of the month. It’s still a sideshow. Only this time, the main event will be the confirmation of longer-term trends in inflation and growth.
