Regional Banks May Emerge as a Winner in Debt Showdown, State Street Says
Bloomberg
Published May 15, 2023 16:56
(Bloomberg) -- Trillions of dollars stowed away in short-term US Treasuries are looking anything but safe as the debt ceiling deadline edges closer. That’s prompted an ETF giant to warn that one of the year’s hottest haven trades could be about to unwind — and throw beleaguered regional banks a lifeline.
Lori Heinel, who oversees the biggest short-term US Treasury ETF as chief-investment officer at State Street (NYSE:STT) Global Advisors, a $3.6 trillion asset manager, is avoiding short-dated US debt in State Street’s actively-managed funds as a showdown in Washington over raising the US government’s $31.4 trillion borrowing limit enters its final days.
While an outright default isn’t her base case, she thinks the deadline will come with a bigger fallout than in previous years. This could spur a reversal of the record $5.3 trillion currently parked in money-market funds, she said. Flows to short-dated US ETFs have already started to slow in recent weeks.
“If they really do press this to a point where there is a technical default or some other extraordinary intervention, perversely it could create a huge flight of money back into bank deposits,” Heinel said in an interview. “Banks could be the most immediate beneficiary as people look for alternatives to Treasury funds.”
The shift could offer some breathing space for US banks, which are still under pressure after a run on deposits triggered the collapse of several regional players. But that respite would be short-lived if the row over raising the debt ceiling causes too much collateral damage.
Heinel is monitoring State Street’s $29.6 billion BIL ETF “as closely as possible” for signs that the market is pricing in a increased likelihood of default. We’ve taken the posture that “tracking the index is the most important thing to do,” she said.
The risk the US fails to meet its obligations by early June would impact those Treasuries coming due most immediately and bill markets are pricing in some risk of default, with the one-month bill yield near 5.5%. Heinel is avoiding short-dated US debt in State Street’s actively-managed funds, preferring to pick up yields from bonds with slightly longer duration.
After being underweight earlier this year, State Street now holds one of its biggest overweight positions in US equities. A better-than-feared earnings season and high proportion of ‘quality’ names, gives Heinel confidence that corporate America will hold up better than other regions in a low-growth environment.
She also sees opportunities in cheap valuations in Europe and prefers to avoid emerging markets, which, she says, are usually hurt more than developed markets when global growth slows. Slowdown fears have led to State Street shifting its overweight in commodities to underweight, focusing instead on high-rated bonds.
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The “dramatic decline in credit availability” due to higher rates has increased the possibility of recession and “probably means that central banks have gone too far already,” Heinel said. Most of the possible outcomes of the row over the debt ceiling — from a last minute deal to the Federal Reserve stepping in as a buyer of last return — would be “yet another weight on an already precarious credit position,” she said.
Written By: Bloomberg
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