As SuperCommittee Fails, Counterintuitive Result Likely

(November 21, 2011) – With the Congressional SuperCommittee set to fail to reach a compromise over debt reductions, chief investment officers should be prepared for a counterintuitive result: an increases in value of their US sovereign debt holdings.

“The global markets continue to act today from a ‘risk on or risk off’ point of view,” according to Steve Case, an investment consultant with Mercer. “U.S. Treasuries are the ‘risk off’ investment of choice. So, having the SuperCommittee fail has a counterintuitive result: people want to reduce risk in their portfolios and in turn purchase U.S. Treasuries as the US Congress fails to act.” 

The so-called SuperCommittee – the result of negotiations earlier in the year over America’s debt ceiling—was meant to come up with $1.2 trillion in budget cuts in hopes of stabilizing the nation’s financial and political situation. Reports out of Washington, however, show the likely result to be failure as the deadline for their work fast approaches.

As Case notes, the beneficiaries of such a political failure and corresponding rise in Treasuries value are those currently with holdings in U.S. debt. Among asset owners, this likely will include those with holdings in strategies such as risk parity products and liability-driven investing strategies (LDI). Those that are looking to enter into an LDI framework, however, could be further disinclined to do so at current bond prices.

RogersCasey’s Tim Barron adds: “Over the last several weeks it became fairly clear that the so called Super Committee was going to fail to deliver on the desired bipartisan approach to a deficit reduction plan. It is equally clear that even if they had arranged some gimmicks to give the illusion of cooperation, the next Congress could unravel everything before there would be any actual impact upon spending or revenue. The Committee’s failure is no more than another guidepost signaling to asset owners that the problems in the U.S. are going to require more drama in the years to come.”

This counterintuitive result should perhaps no longer be counterintuitive. When Standard & Poor’s downgraded U.S. Treasuries earlier this year, a flight to quality ensued—with the winner being U.S. Treasuries. The market movement caught many—including bond guru Bill Gross—unaware.

In an interview with the Financial Times in August, Gross, the manager of the world’s largest bond fund, said that it had been a “mistake to bet so heavily against the price of U.S. government debt.” He noted that he wishes he had invested more in U.S. governmental debt earlier this year. “It was my/our mistake in thinking that the U.S. economy can chug along at 2% real growth rates,” the newspaper cited Gross as saying. “The US and developed economies are near the recessionary dividing point.”