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A U.S. default would destabilize the financial ecosystem, strategist warns

There won’t be many good options for investors to protect themselves from the shock waves unleashed in global financial markets if debt-ceiling talks in Washington fail and the U.S. government willingly defaults, according to Amar Reganti, fixed-income strategist at Hartford Funds.

Wall Street has been paying close attention as the White House and top U.S. lawmakers prepare for a second round of debt-ceiling talks, due to restart Tuesday.

While the likelihood of a U.S. default still appears to be a long shot, concerns have been growing. Treasury Secretary Janet Yellen reiterated a warning on Monday from early May that a U.S. default could happen as soon as June 1 unless Congress raises the federal government’s borrowing limit.

“By and large, the best description is that investors are fish that swim in the ocean of Treasurys, and the dollar is the water,” said Reganti, formerly a deputy director at the Treasury’s office of debt management from 2011-2015. “You have real problems if that ecosystem become destabilized.”

He pointed to the Treasury market’s role as a haven for investors and central banks, but also how its “zero percent” risk weights underpin the banking system. Together with the U.S. dollar,

Treasurys also drive margin lending, clearinghouse activity and borrowing terms for the larger $55 trillion U.S. bond market.

“Our base case is that the debt-ceiling is raised,” Reganti told MarketWatch. But he also said threats of late payments or recurring U.S. debt-ceiling showdowns could challenge the view that Treasurys are extremely easy to liquidate, with limited friction occurring if a holder needs to meet any liquidity need, or the basis of their zero-percent regulatory risk weights.

Related: How $4 trillion in Treasurys parked at banks could become a ticking time bomb if the debt-ceiling fight triggers a U.S. default

“When you start talking about default risks, or delayed payments, you are effectively throwing sand into the liquidity gears,” he said.

Evidence of investor jitters can be found in the roughly $24 trillion Treasury market, specifically in debt that matures before and after the so-called “X-date,” or when the U.S. government is expected to be unable to pay all of its bills without an agreement on the government’s borrowing limit.

The 1-month Treasury yield

was 5.57% on Monday, while the 3-month

rate was at 5.15%. Higher yields are a sign of investor hesitation. Bond prices and yields move in the opposite direction.

The yield on a 4-month bill auction, with a maturity falling within the June 1 X-date, came at a record high of 5.840% a week ago.

Stocks posted moderate gains on Monday, getting help from a rally in shares of regional banks

that have been under fire from lost deposits and the Federal Reserve’s rapid pace of rate hikes in the past year.

The Dow Jones Industrial Average

gained 0.1% on Monday, snapping a five-session skid, while the S&P 500 index

advanced 0.3% and the Nasdaq Composite Index

rose 0.7%.

Related (April 2023): Big question with dollar under fire from rival countries and currencies: What happens to markets if the greenback loses its dominance?

This story originally appeared on Marketwatch

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