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Bond investors refuse to panic despite default fears

October 3, 2013: 1:22 PM ET
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Even though the U.S. is facing another debt ceiling battle, bond investors are not worried. They still see the U.S. as safe.

The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, Abbott Laboratories and AbbVie, La Monica does not own positions in any individual stocks.

The bond market doesn't give a Shiitake mushroom about the government shutdown and debt ceiling drama. But how long can that last?

While stocks have tumbled a bit due to concerns about DC dysfunction, there's been an almost eerie sense of calm among fixed income investors.

The yield on the benchmark 10-year Treasury has been mostly stuck in a narrow range between 2.6% and 2.7% for the past week and a half.

It's as if bond traders are all big fans of "The Hitchhiker's Guide to the Galaxy" or something. Their motto seems to be "Don't Panic." All we need now is for bond yields to suddenly plunge 42 basis points. (h/t @chrisidore.)

But several experts said the lack of a bond market hissy fit makes sense. Here's why.

For one, the market still doesn't believe that politicians will be stupid enough to let the United States default on any of its significant debt obligations -- particularly interest payments to Treasury holders.

Related: Warren Buffett says Congress won't resort to 'extreme idiocy'

The conventional wisdom is that cooler heads will eventually prevail ... or that Treasury Secretary Jack Lew will do his best Hank Paulson impersonation and strike the fear of some supreme deity into Congress to force them to raise the debt ceiling.

There's also that little entity known as the Federal Reserve. It's still buying $85 billion a month in bonds and mortgage-backed securities.

The Fed did not pull back on quantitative easing last month despite expectations that it would. And as I wrote last week, the shutdown and debt limit soap opera may prevent the Fed from tapering until 2014.

As long as the Fed is still buying long-term bonds, that should help keep rates on the 10-year from going much higher than where they are now. After all, the 10-year yield rose as high as 2.98% in early September.

Related: Even talking about default hurts economy

Finally, there's little reason for big bond investors to bail on Treasuries because the U.S. still (amazingly enough) is considered the safest haven in the world when it comes to sovereign debt.

"The U.S. is still the only game in town. There are no obviously superior alternatives," said Richard Portes, a professor of economics at the London Business School.

Sure, China and Japan may eventually grow tired of the political shenanigans on Capitol Hill. And if they do, that would be bad news for the United States considering that those two nations collectively hold more than $2.4 trillion in U.S. debt.

But if they dump Treasuries, what would they buy instead? Despite the improvement in the economies of Europe and Japan, bonds tied to the euro and yen still seem risky.

Related: Countdown to a default

Portes notes that some foreign central banks are gradually moving away from U.S. dollar-denominated assets to bonds and currencies linked to the Canadian dollar, Australian dollar and Swiss francs. But those are relatively small and less liquid markets.

So there you have it. Despite all the fear mongering, it seems highly unlikely that U.S. bond yields are going to skyrocket like Greek, Italian, Spanish and Portuguese bonds did during the worst of the euro crisis.

Keep in mind that even after Lehman went belly up five years ago, bond yields in the U.S. fell. The same thing happened after Standard & Poor's downgraded the credit rating of the U.S. in 2011 following the last debt ceiling debacle.

It may seem silly and completely illogical. But there's nothing like financial turmoil to remind the world that the U.S. is a safe place to invest ... even when Uncle Sam is the source of said turmoil.

It's not as if the U.S. is broke and can't pay its bills. It really is just a more a matter of political stupidity as opposed to catastrophically bad economic fundamentals.

Until something better comes along (and yuan-denominated bonds are probably more a 2050 story than 2013 story) investors are stuck with the U.S. Treasury market -- for better or (mostly) worse.

Reader comment of the Week! Bill Gross of Pimco released his latest monthly outlook on Wednesday. The market's main takeaway was that Gross thinks the Fed will keep interest rates low "for decades to come." But this is Bill Gross we're talking about. He didn't just wax wonky about bonds and the economy.

Gross also had a bizarre tangent on how he hates crows and his wife hates bugs. It was very existential. It almost sounded like he was the Claire Danes character from "My So-Called Life." (Hopefully Angela Chase is a more well-adjusted adult than Carrie Mathison.) One of my college friends picked up on this too.

Ha! Gross is a big music fan. I wonder if he was listening to Morrissey when he wrote that outlook.

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