The markets’ response to the debt ceiling showdown in Washington has so far been muted. Bond traders seem convinced that a deal will be done before August 2 to raise the US government’s borrowing limit and end the risk of an imminent default. With the deadline now just days away, and talks still deadlocked, that view may change at any moment. The calm in markets could vanish.
In the meantime, the fact that US bond yields have not spiked – yet – does not mean the debt ceiling impasse is harmless. The risk of financial dislocation is affecting decisions and doing real damage.
As the Financial Times reported on Wednesday, money market funds have begun to hoard cash in case they have to meet a surge of redemptions. Restrictions on these funds’ short-term lending distort the cost of borrowing and have a knock-on effect for banks, among others, which rely on short-term transactions in the repo market.