Shutdown foils asset owners and managers
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October 14, 2013 01:00 AM

Shutdown foils asset owners and managers

Harder to do their jobs without employment stats, answers on regulations and exemptions

Hazel Bradford
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    Russell Investments sold Treasuries coming due in October to cut credit risk, said Gerard Fitzpatrick.

    (updated with correction)

    The political paralysis in Washington that shut down the federal government Oct. 1 and is bringing the U.S. within days of breaching its debt ceiling is taking a toll on institutional investors, from spiking short-term borrowing costs and market uncertainty to general frustration.

    The disruptions range from small, but annoying, glitches like those that faced organizers of the EDHEC-Risk Days North America conference in New York Oct. 8, where conference materials shipped from France were delayed due to short staffing at a U.S. Customs facility.

    One of the biggest gaps for money managers is the silence from the Department of Labor's Bureau of Labor Statistics, which produces monthly employment figures used as a key economic indicator. The October numbers did not come out as scheduled Oct. 4, and managers are already worried about the batch scheduled for release Nov. 1.

    “I think every asset manager is looking at every asset class you are trading,” said Michael O'Brien, vice president and director of global trading for Eaton Vance Management in Boston. “It's a critical number and we didn't get it. You're somewhat flying blind.”

    For Bob Holcomb, executive director for legislative and regulatory affairs for J.P. Morgan Asset Management, the shutdown means there is nobody at the Department of Labor's Employee Benefit Security Administration to handle questions on regulations or exemptions, let alone much-anticipated guidance on fee disclosure, lifetime income projections and more.

    “The regulatory agenda at DOL has kind of come to a standstill,” Mr. Holcomb said. “There are only about 14 people in Washington and none of them are connected with ... the areas we care about.”

    The silence at the Commodity Futures Trading Commission is making life confusing for asset managers just getting used to new trading and clearing rules for the derivatives market, where U.S. Treasuries play a big role. “Both the buy side and sell side have significant concerns,” said Mr. O'Brien, noting the uncertainty has prompted traders to revert to trading by voice instead of electronically. “We've taken a big step back,” he said.

    Between the dark CFTC and U.S. Department of Agriculture, commodity traders are left to their own devices for getting commodity pricing on some futures contracts and other market reports that help derivatives traders track prices and trends.

    It's also affecting the repurchase agreements that derivatives traders strike with banks to buy and sell Treasuries. “In a calm market, repos are very attractive,” said Mr. O'Brien. When there is turmoil (over government bond risks), “it can put stress on the entire financial system.”

    And then there is the bond market, which has seen plenty of upheaval as major players like Fidelity Investments seek to avoid Treasury securities that mature in the coming weeks, or even move into cash or European debt.

    BlackRock Inc. also said it was reducing exposure to the riskiest Treasury maturities.. In a statement, BlackRock said it has actively managed its money market funds in recent weeks “with an eye toward the possibility that the government could reach its borrowing authority after Oct. 17. We continue to take prudent actions in preparation for all potential outcomes.”

    What bond buyers think

    With the federal government needing to borrow an estimated $11 billion each week from buyers of Treasuries, President Barack Obama last week recognized the importance of bond buyers, who are starting to demand higher yields for their perceived risk. “Ultimately, what matters is: What do the people who are buying Treasury bills think?” Mr. Obama told reporters.

    Yields 30-day U.S. Treasury bills spiked from 0.023% on Sept. 30 to as high as 0.34% on Oct. 8, before falling — and ending the week at 0.22% on Friday, Oct. 11.

    Going into this quarter, Russell Investments in Seattle began trimming its credit risk exposure by reducing holdings at the short end of the yield curve, and increasing at the long end, said Gerard Fitzpatrick, CIO for global fixed income, “and we expect continued pressure as anxieties mount.”

    “This is all so consistent with what we've seen from the start of the financial crisis in 2008, with the big blowup of credit, the ratings issues, and the credibility of sovereign (debt) in question. If the U.S. doesn't act appropriately, that is a slippery slide. There's no panic button right now, but it could be formative for the long-term future.”

    Similar to rate spikes seen during the 2011 debt drama, rates on the Treasuries most at risk have risen sharply, with yields on Treasuries maturing by the end of October rising as much as 25 basis points by Oct. 8 from two basis points on Sept. 24.

    The price of credit default swaps on six-month and one-year Treasuries, which insure against default on them, multiplied fivefold in recent weeks.

    Mr. Fitzpatrick and others still see fundamental strength in the U.S. economy, which is reflected in the equities market. A September survey of 100 investment managers by Northern Trust Corp. found that 90% expect at most a modest short-term impact from the shutdown and debt ceiling standoff, which Christopher Vella, chief investment officer for multimanager solutions, attributes to money managers deciding that the gradual strengthening of key indicators would prevail over short-term political factors.

    But John Greenwood, chief economist of Invesco Ltd., London, worries about the economic damage from federal worker furloughs and government-reliant contracts that are in limbo, which he estimates causes U.S. GDP to fall by $1.6 billion for each week of paralysis. Comparing that to natural disasters that cause billions in damages, a continued standoff “would be like one hurricane per week,” he said.

    Hurting household wealth

    Treasury officials note that during the 2011 debt-limit debate, the fall in equity prices caused household wealth to plummet $2.4 trillion, which is not insignificant economically when consumer spending accounts for as much as 70% of GDP. This time around, Treasury officials said, even a weeklong shutdown could slow GDP growth in the fourth quarter by a quarter percentage point; a longer one could even cause a recession.

    Most people expect a last-minute deal before the Oct. 17 debt ceiling deadline , but in the meantime, the shutdown has caused money managers to spend a lot of time on contingency planning.

    “From a fiduciary perspective, we're taking this very seriously,” said Libby Cantrill, New York-based executive vice president of Pacific Investment Management Co., which has a working group preparing for the possibility of a government default. “We're planning for the worst even though we are expecting the best,” she said.

    PIMCO's Josh Thimons, a Newport Beach, Calif.-based managing director and portfolio manager who focuses on interest rate derivatives, has seen some red flags as the markets react to the lack of action from Washington, “but in general the markets are behaving with a rather benign outlook,” said Mr. Thimons. “The markets expect that there will be some sort of solution at the eleventh hour.”

    Unlike the 2011 version, this round of government shutdown and debt ceiling crisis is not even raising the possibility of dealing with long-term government spending problems like federal debt and unchecked entitlement spending. “It just seems like more kicking the can down the road,” said Ms. Cantrill. “There is not much chance of a grand bargain this time around. We think it's going to be a mini bargain and what's politically tenable.”

    Bloomberg contributed to this story.

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