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With Default Looming, Is Now The Time to Short U.S. Treasuries?

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As the fruitless debt-ceiling negotiations make a U.S. default ever more likely, planners face a question: Should they recommend that concerned clients shift their assets or, even more boldly, short U.S. Treasuries?

The answer is that advisors should be prepared, but not necessarily make a dramatic move, said Laura LaRosa, director of fixed-income management at Philadelphia-based wealth manager Glenmede.

“If you do go out and take a proactive move -- let’s say shorting Treasuries -- and the debt ceiling is then raised, then maybe you made bad move,” she said.

 A more sensible option is increasing worried clients’ cash position, she said. “Raising cash, taking a little bit of profit off the table is probably not a bad idea. At least that gives you the opportunity to maneuver very adeptly if the debt ceiling is not raised.”

 Such considerations seemed unnecessary just a few weeks ago.

LaRosa believes the odds of default have now jumped to as high as 20%. “Maybe one or two months ago, I’d assigned a very small probability, 5%, to (the debt ceiling) not being raised,” she said. 

If the lack of a deal and the prospect of a default causes dislocation in the markets, that can spell opportunity. Instances of “irrational” dislocation are always good buying opportunities, she said.

 “In our portfolios, we’ve identified the short bonds we’d sell,” she adds. “We’d move way out the curve to capture yield.”

From a longer-term point of view, the debt-ceiling foibles in Washington illustrate the importance of a global, broadly diversified portfolio, according to the Schwab Center for Financial Research. 

In a recent market commentary, however, Schwab’s experts stressed that default on US Treasury debt remains unlikely.

 The U.S. Treasury has indicated that the consequences if a debt-ceiling deal is not struck could include delays in the payments of Social Security, Medicare and military salaries and, ultimately, default.

A deal on the ceiling would probably be needed by July 22 to meet the August 2 deadline for completed legislation, according to the Schwab Center for Financial Research. Draft legislation would have to be voted on and both the House and Senate must vote to approve it, meaning they would have to forge a difficult consensus.

The three major bond rating agencies have said they will lower the country’s AAA bond rating even if interest and principal payments are interrupted for only a few days.

In that event, however, Schwab still expects that global demand for Treasuries will continue and that confidence in ultimate payment will continue. Treasury yields would likely rise in the event of a default.

 “One of the things that makes us worried is the question of whether the politicians realize the seriousness of the situation,” LaRosa said.




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