Debt ceiling: Investors acting like ostriches?

July 14, 2011: 1:19 PM ET
With long-term rates so low, it seems the bond market is not worried about a U.S. debt default. But do investors have their heads in the sand?

With long-term rates so low, it seems the bond market is not worried about a U.S. debt default. But do investors have their heads in the sand? Click chart for more on bonds.

NEW YORK (CNNMoney) -- There is a lot of talk about how politicians are playing a game of chicken with the debt ceiling.

But when you consider how calm the market -- especially bond investors -- have been as the August 2 D-Day approaches, another avian creature comes to mind: the ostrich.

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Are fixed-income investors burying their head in the sand and ignoring the possibility that Republicans and Democrats won't play nice and raise the debt ceiling?

Bond rating agency Moody's said late Wednesday it was putting U.S. debt on review for a possible downgrade if there is no agreement to boost the borrowing limit -- which would likely result in the government missing interest payments to creditors.

And Moody's rival Standard & Poor's has reportedly told lawmakers that it may downgrade the U.S. even if it doesn't technically default.

Fed chairman Ben Bernanke has been using the word "calamity" in front of Congress the past two days to describe what would happen if the debt ceiling is not raised.

Still, the yield on the 10-Year U.S. Treasury is a very low 2.92%, a sign that there is strong demand for Uncle Sam's debt despite the dire warnings about what might happen if there is no deficit deal. (Bond yields fall as their prices get pushed up.)

More on America's debt crisis

Contrast the low rates in America with the yields on long-term bonds from some of the troubled nations in Europe. Italy's 10 Year government bond yields 5.6%, for example.

And that's nothing compared to the rates for the most troublesome three little PIIGS-ies in the Euro Zone. Portugal's 10 Year yield is 12.7%. Ireland's 10 Year yield is 13.9% And in Greece, aka the birthplace of this current sovereign debt crisis (as well as democracy), the 10 Year yield is a staggering 17.1%.

Of course, U.S. Treasury yields shouldn't be trading at Italy-like levels, let alone the double-digit rates of Portugal, Ireland and Greece. But shouldn't bond investors be a little more nervous?

Amazingly enough, most experts say no. That's because they still believe that despite the jawboning in Washington, the market has faith that the president and Congress will eventually hammer out a deal before the nightmare scenario of bond defaults and no Social Security checks unfolds.

"When you look at Treasury yields, the market does not seem to be disturbed by this at all," said Jeffrey Cleveland, senior economist at Payden & Rygel, a money management firm in Los Angeles. "There are lots of questions about whether the U.S. will default, but it seems unlikely to happen."

In other words, the hope is that even though Washington may push the market to the precipice, it will not actually take it over the cliff like it did in the autumn of 2008 with the bank bailout.

Remember those fun days? Congress actually voted against TARP the first time it came to the floor, only to watch the Dow plummet nearly 800 points.

You have to think that the buffoons in Washington (many of whom were in Congress in 2008) remember that market plunge. So you would think they would want to do everything they could to avoid a sequel, right? Right?

One would hope. But sadly, lawmakers may feel that they can afford to wait. First, they apparently need to prove to their base that they are not going to be the ones to cave in to the demands of their political opponents. Essentially, they are holding off on shopping for presents until Christmas Eve.

"Investors just do not believe politicians won't come to an agreement on the debt ceiling," said Keith Springer, president of Springer Financial Advisors in Sacramento. "We are used to the partisan jockeying by now. It seems to me they are close to a deal but are just bickering and waiting to the last minute."

Video: How a debt default could impact you

If that's true, then I guess it does make sense for yields to be this low. Springer and Cleveland both said that the bond market is worried about sluggish U.S. economic growth -- and a plan to raise the debt ceiling is not going to rejuvenate the stagnant job market.

Joe Balestrino, chief fixed income market strategist with Federated Investors in Pittsburgh, added that he thinks the bond market (as well as our big creditors like China) recognize that if the U.S. does actually default, it's more due to political reasons than economic ones.

Even if we lose our pristine triple-A rating, U.S. debt may still look reasonably attractive compared to the bonds of other nations.

"Treasuries still seem to be benefiting from a flight to quality. Even if the U.S. defaults, where does one go for quality? Germany and Japan don't seem to be great alternatives either," Balestrino said.

But at least one money manager said that is wishful thinking and that investors cannot rule out the possibility that August 2 comes and goes without a debt ceiling/deficit reduction agreement.

"Nobody can bring themselves to believe that these people in Washington are that dumb. But the scary thought is maybe they are," said George Feiger, CEO of Contango Capital Advisors in San Francisco. "If there is no deal, there will be a huge move up in long-term bond yields."

The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, and Abbott Laboratories, La Monica does not own positions in any individual stocks. To top of page

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