Bifurcated

Bifurcated: divided into two branches or parts (Merriam-Webster)

On the LHS is not the share price of a MEME stock but illustrates the recent parabolic move in the yield of the 3-month US Treasury bill (yields move inversely prices), arguably the safest investment on the planet.

The message from money markets: Fears over a possible US default are justified, and real.

Meanwhile, on the RHS, risk assets continue to remain remarkably well-behaved, evidenced by a fresh ATH high in the relative performance of US equities (S&P total return index) vs long-term US bonds (TLT Index) this week.

The message from equity markets: jitters over a default are grossly overblown and a deal will be done, period.

Turning the clock back just over a decade, the summer of 2011 is the closest analogy we have to the current dilemma facing politicians and financial markets. Interestingly, the eventual deal that was agreed upon did not bookend the saga but served as the catalyst for a fresh wave of problems.

Worries that significant cuts to US government spending would crimp growth were enough to trigger an S&P downgrade of the country’s sovereign debt rating from AAA to AA+, whilst the Fed were forced to step in with extraordinary measures to compress long duration bond yields. The S&P would fall almost 20% during that summer before finding a floor.

In addition to continued pressure from international holders of US debt, there are added complications this time round:

• Headline inflation readings and various core components remain hot and sticky, putting Chairman Powell and the Fed in the proverbial straitjacket.
• The argument that a US default will lead capital flows to seek out the haven of, that’s right, US debt, is not necessarily a fait accompli.
• Recent bond yield movements suggest waning confidence that the Fed will ease.
• House Speaker Kevin McCarthy remains in a precarious position, with the spectre of his removal by hard-line Republicans still looming over negotiations.

Something’s gotta give.