Bond experts to Congress: Don't mess it up

Professional investors are used to theatrics when it comes to Congress and the debt ceiling.They just hope lawmakers don't turn the drama into a debacle this time.

NEW YORK (CNNMoney) -- How the bond market will respond as the debt ceiling standoff drags on is the $14 trillion question.

Of course, that hasn't stopped politicians from asserting what will happen if the debt ceiling isn't raised by Aug. 2, or if it is raised without accompanying spending cuts.

But the truth is nobody can really know. And bond experts know that better than anyone. CNNMoney talked to seven of them for their latest take on the debt ceiling drama.

All of them said they remain confident that Congress will raise the debt ceiling by Aug. 2. That is when Treasury Secretary Tim Geithner has said he will run out of ways to keep the country below its $14.3 trillion legal borrowing limit.

But they're not amused by lawmakers' theatrics.

Debt ceiling: What you need to know

"These people do play games, they do position themselves," said Michael Cheah, a bond fund manager at SunAmerica. Then like college students, he said, they'll stay up all night cramming for the exam. "They'll pass with a 51."

Many of the bond experts indicated they would welcome a plan for deficit reduction if it were tied to the vote, but no one said the ceiling shouldn't be raised in the absence of one.

"You link them together tightly at your own risk. The debt ceiling is a condition of doing business," said Steve Van Order, a fixed income strategist at Calvert Investments.

Nor was anyone sanguine about the risks Congress could run if it fails to raise the debt ceiling this summer.

"There are reasons to believe that such a situation could raise the probability of unusual volatility in financial markets," said Mohamed El-Erian, CEO of Pimco Investments, the world's largest bond investor.

And that could drive up interest rates, undermine stocks, hurt the dollar and "raise questions about the standing of the country," El-Erian added.

Van Order doesn't think the bond market would perceive the United States to be in default so long as it continues to pay the principal and interest owed on its debt. But that doesn't mean the country won't be hurt since it would have to put off paying other obligations, he said.

"You start to look like a banana republic," Van Order said. "If [lawmakers are] willing to take it to that level then there's a whole new level of instability in the U.S. government that we didn't know was there."

Cheah was harsher: "If they postpone payments, they're just showing the world how stupid they are."

The concern is that postponing payments might make investors worry that just because they're in line to be paid today, tomorrow could be a different story.

"One of the things to be avoided is the perception that debt service is negotiable," said Ken Naehu, head of fixed income at Bel Air Investment Advisers.

Matthew King, chief investment officer at Bell Investment Advisor, agrees. "What concerns me most is that investors could lose confidence in the ability of the U.S. to make good on its next set of interest payments. He noted that the Treasury doesn't actually have to miss a payment for Treasury yields to jump "significantly."

Conversely and ironically, yields may stay low if the debt ceiling debate becomes a debacle and causes a stock sell-off, Van Order surmised. In that case, investors could run to the bond market seeking safety -- a relative term to be sure.

Contributing to the lack of certainty about the outcome of this standoff is a four-letter word: TARP.

On Sept. 29, 2008, the world witnessed one of the most heart-stopping moments in investment and legislative history: To everyone's surprise, the House voted down the $700 billion bailout package that the Bush administration had said was needed to save the economy from collapse.

Stocks promptly went into free fall, plummeting nearly 900 points before ending the day down 778 points, or 7%. More than $1 trillion in market value was erased in an afternoon.

By the end of that week, the House relented, passing a very similar version of TARP that it had rejected days before.

For bond experts, TARP is a cautionary tale: You never know what Congress might do.