Fund of $793 Billion Bets on US Debt Drama Rerun

PGIM Fixed income has spotted a chance to bet the next crisis as US politicians discuss ways to avoid a historic default on debt.

Greg Peters (co-chief investment officer) of the firm has purchased long-dated credit-default swaps – insurance against future default – on the assumption that the US would find itself in the same situation again.

Investors are in a difficult situation: while politicians seem to be close to reaching a debt ceiling deal, the X date — when the government will no longer be able to pay its obligations — has gotten dangerously near.

Due to market fluctuations around the X-date, some investors bet on short-dated Treasury Bills. Peters, who oversees $793 Billion in assets at PGIM Fixed income, says that these bets are not worth it. He’s instead focusing on US CDS curve.

In a telephone interview, he stated that “the US CDS curve has a high inversion. This means that people will be paying more for default protection over the next few years.” “We went a little out of the curve, because we have a sneaking suspicion that this will continue every year.” “The congressional disruption in DC will not be going away any time soon.”Washington’s debt ceiling is increasingly a weapon of partisanship. The current impasse is bringing back memories of 2011, where talks were tense and Standard & Poor’s downgraded the US government’s credit rating, causing global markets to erupt.

Traders have become jittery. The ICE BofA MOVE Index is a widely-used gauge of bond volatility. It has risen to levels seen last during the Great Financial Crisis.

Treasury Secretary Janet Yellen stated Monday that it is now “highly probable” that her Department will run out cash by early June. This could happen as early as June 1. PGIM assigned a 5% chance of a default this summer. While low, it is still “higher than should be”, according to Peters, a former Treasury employee.

He said, “It is a very hard investment thesis since you have a high probability of a catastrophe.” What do you do? It’s the opposite of a lotto ticket! It implies that you are taking a risk closer to home.”

Peters is also still wary of inflation and sees interest rate cuts as excessive even though the markets have started to fade. James Bullard, a Federal Reserve official, said on Monday that he supports two additional rate increases in 2023 following the hawkish remarks made by his Minneapolis colleague Neel Kazhkari.

Peters stated, “I believe that the front-end rate will remain higher than what’s being charged in the marketplace.” “Even if there is a recession I believe it will already be reflected in the prices.”