Analysis – Debt Ceiling Crises Refines Examination of U.S. Safe-haven Status
LONDON (Reuters) – Disputes over US debt ceiling and the euro’s growing dominance of bond issues linked to environmental or sustainability goals could start to undermine the status of T-bills as a reserve asset ultimate, enabling Europe to increase its share.
The $ 22 trillion US government bond market is the foundation of the global financial system with unparalleled depth and liquidity. Considered a super safe asset that will never fail, it supports the dollar as the world’s leading reserve currency.
Except that a default, even if only a short-term technical default, no longer appears to be an impossibility and could harm the image of Treasuries as a safe haven, analysts and investors believe.
As the Treasury repeatedly hits borrowing limits, the growing polarization of Congress has in recent years turned what should be a simple vote to raise the debt ceiling into a series of protracted crises.
While an October default was recently avoided, the stalemate will likely resume with a longer term solution required by early December.
Which doesn’t mean the dollar is about to fall off its pedestal. Changes in reserve status take place over decades, and aside from the ease of trading treasury bills, most of the world’s trade is still priced in greenbacks.
Still, a process could be underway for Treasuries to cede part of their shares to rivals, especially the euro, as investors and companies warn of the financial damage resulting from treating the debt ceiling as a redemption. partisan weapon.
“Every time that sort of thing happens, it gradually erodes international confidence in treasury bills. You cannot say that the United States does not lose its pen every time it politicizes the debt ceiling issue, ”said Thomas Costerg, senior economist at Pictet Wealth Management.
Chart: IMF foreign exchange reserves in Q2 –
Even a partial erosion of reserve status would impose significant costs on U.S. taxpayers, according to a recent Brookings Institution article.
The paper estimated that the unsurpassed security of treasury bills reduces the government’s borrowing costs by 25 basis points on average compared to other large sovereign issuers. At current debt levels, that translates into interest savings of around $ 60 billion this year and over $ 700 billion over the next decade.
OCEANS RISE, EMPIRES FALL
Data from the International Monetary Fund shows that the share of dollar reserves held by central banks fell to 59% to its lowest level in 25 years at the end of 2020 and is holding near those levels.
Overall, last year, investors sold Treasuries while buying Japanese and German government bonds, according to a study by the Institute of International Finance (IIF).
Chart: Foreign flows in Treasury bills vs peers, 2009 and 2020 –
One explanation is that central banks in emerging markets were forced to sell Treasuries during the pandemic crisis, but IIR chief economist Robin Brooks also notes that bonds have not acted like the Safe haven they should be during the market collapse in March 2020 – when a sell-off pushed yields higher before Federal Reserve intervention stabilizes markets.
“What matters – if you’re a safe haven asset that T-bills claim to be – is that you get entry when times are tough and risk appetite is low,” Brooks said. “It didn’t happen last year, but it did happen very noticeably for the German Bunds.”
The euro represents a fifth of the world’s foreign exchange reserves, but has been hampered by the lack of a sizable “safe” asset. German AAA-rated bonds stand at just 1.6 trillion euros ($ 1.9 trillion), a tiny amount compared to the market of $ 20 trillion plus the Treasury.
Fractured US politics, however, contrast with European cohesion during the COVID crisis and the creation of a € 800 billion common fund canceled the risk of the euro zone breaking up and will increase the pool of ‘assets denominated in euros rated AAA.
Chart: The cost of insurance against default, US vs Italy –
Christian Kopf, CIO for fixed income and forex at Union Investments, said he was surprised by the demand for euro-denominated assets from Asian clients, especially in South Korea. He noted that the supply of these assets exceeds € 4 trillion including all bonds with a consistently strong and superior AA- rating.
A more important future selling point could be the euro’s dominance over bonds meeting environmental, social and governance (ESG) criteria, which finance projects that benefit the climate or society.
Almost half of new global green bond issuance was in euros last year, up from 28% in dollars, according to Marcus Pratsch, head of sustainable bonds and finance at DZ Bank.
These securities are in high demand, with the European Union’s green bond of € 12 billion this week inundated with € 135 billion in orders. The US Treasury has yet to issue green debt.
Central banks want more ESG exposure, according to a 2019 Morgan Stanley and IIR survey. Japan announced last week that it would start using its reserves to buy ESG stocks.
“The euro will remain the most sought-after currency in the sustainable bond market, further strengthening its international role,” predicted Pratsch.
Chart: ESG bond issue in US dollars vs euros –
Reporting by Dhara Ranasinghe; additional reporting by Sujata Rao and Tom Arnold; Editing by Sujata Rao and Kirsten Donovan