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October 30, 2013
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The Federal Government has reopened. National Parks and monuments are available for tourists to visit. The panda-cam at the National Zoo has been turned back on.


So perhaps the government shutdown and debt ceiling debate were sensationalized by the politicians, and the media-frenzy feeding the politicians didn’t help. While it was real for the hundreds of thousands of government employees who were furloughed and subsequently received back-pay for the 16 days off work (and equally important were the private sector employees who were also furloughed without government contacts), it was quite a spectacle to behold from outside the Beltway.

The risk of the federal government actually defaulting on October 17th was virtually zero, as Treasury had roughly $30 billion on hand to pay expenses. The true default would have occurred sometime around Halloween, and likely would have been cured within 24 hours. Alas, leaders of Congress passed legislation to fund the government until January 15, 2014 and temporarily remove the debt limit until February 7.

But where does this leave us? A bicameral committee is tasked with finding a compromise between House and Senate budget bills and report back by December 13th. There’s no gauntlet hanging over the economy should this process fail. It is simply a milepost as we move towards January 15th; don’t expect a “Grand Bargain” coming out of this process.

In part, we are still betrothed to a finite horizon and potential political turmoil. Given the beating the Republican party took in the eyes of American voters (let alone international investors), it seems unlikely we will run up against similar wrangling in early January. Republican leaders will likely rein in the Ted Cruz’s of the world and maintain a united front negotiating entitlement reform and lower taxes while Democrats look to reduce defense spending and higher taxes. Absent substantial revisions to the tax code, we will likely see a patchwork of deals being made to pass yet another funding resolution.

As for the debt limit, we may also see this punted until after fall elections (is punting the can down the road longer than kicking the can down the road?). While an outright budget and unconditional debt limit increase would build confidence in our elected officials, it doesn’t appear likely. The political risk premium may vacillate, but it’s unlikely to decline permanently.

So what should a cash investor do, if anything? We hold to the idea that US Treasury and US government guaranteed securities remain appropriate for investors. However, there are many sides to risk, and as we saw earlier this month, liquidity risk (the ability to sell a security quickly at a reasonable price) is real, even for US Treasuries. A diversified portfolio – across maturities as well as issuers – can help to reduce risk, including liquidity risk. During the two week government shutdown, yields on short term Treasuries jumped to more than 0.50%, while yields on high quality commercial paper were stable at about 0.15%. Some investors will continue to only invest in US government securities, believing that credit risk is more important than liquidity risk. Others may look to broaden their investment exposure to include high quality corporate issuers to further diversify their investments, and rightfully expect to reduce their total risk.

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