Commentary
The debt ceiling debate in Washington has been widely discussed but so far, few investors are truly worried.
Most believe that when the deadline arrives, Congress and the White House will reach an agreement—even if it’s to kick the can down the road. As of now, Treasury Secretary Janet Yellen has set the deadline as June 1. There are still a few weeks left, and if history is any indication, no resolution is likely to be reached until the 11th hour.
So far, institutional investors haven’t entirely balked at buying new issue U.S. Treasury bills. During the May 11 Treasury auction, four-week T-bills drew an annualized bond yield of 5.723 percent, a high but not exorbitant interest rate for bonds expiring on June 13. The eight-week T-bills were sold with an annualized yield of 4.793 percent by contrast.
Usually, longer-duration paper will have a higher yield. But this recent disconnect, that the four-week bills cost more than the either-week bills, reflects some concern that the June 13 T-bills won’t be paid on time while the July 11 paper will. This assumes a new debt deal will be in place by July. But even recognizing that, the 5.723 percent yield is no indication that any catastrophic debt default event is expected to pass.
What should investors do if there is indeed a debt default, or if the debt ceiling fight gets ugly and no deal is in sight?
Enter Gold
Gold has approached its record high in recent weeks without much fanfare. That’s an impressive feat given that gold pays no yield and bond yields remain very high. The gold spot price has climbed by about 10 percent this year through May 12.
There have been a few causes of gold’s recent rise. Global central banks bought 228 metric tons of gold during the first quarter of 2023, according to the World Gold Council. That’s after they collectively added 1,136 metric tons in 2022, a record year. Part of this demand has been driven by certain countries moving away from the U.S. dollar for global trade and potentially establishing a new common settlement currency.
Gold had a previous extraordinary run during the 1970s. President Richard Nixon ended the Bretton Woods system, under which the dollar was converted into gold (at $35 per ounce), in 1971. Gold then eclipsed $850 per ounce by January 1980—a 24-fold increase. Gold served as an effective inflation hedge during a period of high inflation during the 1970s, when inflation averaged nearly 7 percent during the decade and culminated at 14 percent by 1980.
Silver, which usually outperforms gold in a bull market, has increased by 7 percent to $25.01 this year through May 12. Silver grew from $3 an ounce in the early 2000s and exploded to almost $50 in 2011. At about $25 per ounce today, it remains to be seen how silver will track gold and inflation going forward.
What Else Is in Play?
Currently, the Swiss franc has proven itself to be the strongest currency and an FX haven in a volatile year for global foreign exchange market. During the past 12 months, the franc gained by more than 11 percent against the USD, while notching a four-decade high against its traditional currency haven competitor, the Japanese yen, by early May.
Global currency traders have been betting that the Bank of Japan will keep its ultra-loose monetary policy, which will keep the yen weak against a basket of global currencies. The Swiss National Bank, in the meantime, began hiking rates last year.
But is there value in holding Treasury bills or bonds?
Many investors say yes, despite the risk that the United States may not pay its bills on time.
Former PIMCO Chief Investment Officer Bill Gross recently advised clients to take advantage of the 1 percent of extra annual yield on the shorter-term T-bills despite default risk. The assumption is that a deal will definitely be reached even if the U.S. government can’t pay its obligations for a short period of time.
