Our U.S. Bond Strategy service recommends monitoring several policy-sensitive indicators to determine whether we are setting up for a repeat of the mid-2011 debt ceiling crisis.
T he following indicators together might help decide whether our exposure to spread products should be reduced to neutral or possibly underweight.
- The U.S. 5-year CDS spread, edged steadily higher from 36 to 65 basis points at the height of the 2011 debt ceiling crisis.
- Also, the Baker, Bloom and Davis Policy News Uncertainty Index moved steadily higher in 2011 reaching a peak in August.
- Similarly, the Gallup economic confidence index dropped sharply during July, reaching a cycle low in early August. This indicator was also probably responding to the developing European debt crisis, but the fact that it gradually recovered in the second half of 2011 even as the European situation worsened suggests it was more affected by domestic U.S. concerns.
- Finally, as the debt ceiling crisis came to a head in late July, the possibility that intransigence on the part of policymakers might potentially lead to technical default caused a spike in the 1-month T-bill rate. The jump in default risk coincides with the steepest part of the decline in risk assets and precedes the actual downgrade of the U.S. credit rating by S&P on August 5.
Bottom Line: Risk assets face several speed bumps in the months ahead tied to the domestic policy outlook. Any post-election honeymoon might provide a good opportunity to pare exposure to spread products.