Despite vague hints of support over the past few days, the bond market is back to the same old tricks seen last week.  It's actually a pretty simple trick: ignore the buy button while hitting the sell button.  Today's installment is drawing inspiration from ongoing resilience in Jobless Claims data, the promise of a debt ceiling resolution, and the supply headwinds associated with the Treasury auction cycle.  

Many people have asked us some iteration of the question, phrased as a statement: "But I thought that bonds would ______ when the debt ceiling deal happens/doesn't happen?!" 

Let's clear this up with bullet points.  And keep in mind, this is just my opinion on the matter, but I'm pretty sure recent trading has validated it.

  • The debt ceiling debate is a separate issue from the US government defaulting on its debt.
  • Failure to secure a deal before some imaginary "deadline" doesn't mean the US will default
  • Default has never happened.  It would be catastrophic, perhaps, simply for operational reasons in the global financial system.  It almost certainly won't happen now, and the market isn't trading default risk when it trades the debt ceiling.  That said, some ultra short term bonds are trading the prospect of delayed payments as a part of some emergency workaround (bottom line here: no one believes the US is insolvent.  Everyone knows politicians are playing political games).
  • No one knows how long the US could pay its bills without a debt ceiling deal, but it's guaranteed to be a LOT longer than anyone has claimed.  All of the claims are negotiation tactics.
  • In general, debt ceiling drama is "risk-off" for markets.  It is a net positive for bonds.  And yes, this is counterintuitive if you associate debt ceiling drama with default risk, as most people logically, but mistakenly do.
  • That means a debt ceiling deal would put upward pressure on rates.  This is what we've seen with various headlines and the promise of progress recently.  
  • All that having been said, the debt ceiling is not a market mover in a lasting sense.  It's a zero sum game for long-term momentum.  It only creates short to medium term volatility that allows traders to capitalize on headlines.  The only exception would be to whatever extent the whole ordeal saps confidence and economic activity.  In that sense, it's net positive for rates.

In other words, rates are at the highest levels in months and it has nothing to do with the debt ceiling.  In fact, if there were no debt ceiling debate this year, rates might be even higher.  

Yields had entered the sub 3.60 range (or "re-entered," to be fair) in March after the SVB failure.  They were waiting to see fallout from banking issues that has thus fair failed to materialize.  If that fallout remains missing, it's logical for rates to tiptoe back toward early March levels, assuming econ data isn't deteriorating for other reasons.  It's not.  Moreover, the Fed has been right there to remind us of that fact, thus making the recent range breakout and additional weakness--dare we say--fairly logical.