US10Y – Government Shutdown Panic. What Panic?

If you read major newswires today, you may see some journalists writing the latest US Shutdown as though that the end of the world is nigh. However, price actions of risk correlated assets proved otherwise.  Nikkei 225 actually traded higher, European bourses are also pushing higher, while US stock futures are trading higher, as though that the latest political impasse which may cost the economy US$10 Billion a week (according to White House estimates) is a good thing.

Similarly, Gold prices did not rally but stayed around yesterday US closing levels, while Copper actually traded slightly higher in the few hours after the partial shutdown has been announced. Treasuries were also unaffected, and perhaps give us the best gauge of what the market is thinking.

In theory, if Democrats and Republicans are not able to put aside their differences (a chasm the size of Obamacare) and prevent a (hopefully temporary) loss of close to 800,000 jobs, it is entirely possible that they’ll not be able to resolve it by 17th October, when Treasury Secretary Jack Lew has stated that as the date where US will hit the debt ceiling and potentially default on debt repayments as they are currently running a budget deficit.

Rightly or wrongly, market totally does not expect US to default. Even rating agency Standard and Poor’s issued a statement affirming US AA+ credit rating yesterday, suggesting that even they believe US will make good of the debt ceiling fiasco. Looking at prices of 10Y Futures on Monday open, prices actually gaped higher following the House of Representatives Bill which started the whole Shutdown talk. This suggest that traders are actually BUYING MORE Treasuries. Leading us to this conclusion – Shutdown is bad for US economy, but in terms of defaulting market is still not convinced.

US 10Y Hourly Chart

This is true even when we look at price action today. The largest sell off of 10Y happened at 9pm EDT, when there was still a chance that Republicans and Democrats will be able to reach an agreement. When it was certain that the deal is not going to happen, 10Y prices actually rallied higher. Overall, immediate short-term trend is down, with a Channel being formed from Monday’s high, but overall trend remains on the upside with 127.0 support holding. Even right now prices have not reached the lows of today, suggesting that fears of a US credit default is not even as strong as previous speculative sentiment.

What this mean is that the downside risk for Treasuries is high as there could be the off chance that a resolution is not made by 17th October. This is true even before taking into consideration of an eventual QE tapering cut which will happen in 2014 if not in 2013. However, that does not meant that a test of 127.0 will definitely succeed, but rather traders need to consider the merits of holding US Treasuries for the long haul given all these issues.

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