With the debt ceiling looming, Wall Street and Washington only have rough plans

In the month before the debt ceiling was raised in the summer of 2011, short-dated government bonds, known as bills, fell in value rapidly, sending their yields – an indicator of the government’s borrowing costs for three months – sharply higher. Stock prices fell and the 10-year Treasury yield moved in the opposite direction, in part because investors still viewed it as a safe place to park their money.

But in 2011 there was no actual default. The only time the United States failed to pay a bill was in 1979 — but that was after an agreement was reached and because of a technical problem.

Some investors have begun to explore safeguards in the event the United States defaults on its debt. A trader at BNP Paribas recently sent some investors prices for US credit default swaps, which offer some insurance for a small premium and pay them any money they lose if the government doesn’t pay them on time. Such a price list is rare because interest rates on American debt protection are usually low given the likelihood of default. The price of these contracts has risen steadily over the past six months, indicating a higher, albeit still low, likelihood of the debt ceiling being breached.

Priya Misra, head of global interest rate strategy at TD, said while analysts and investors pondered the possibility of a debt ceiling catastrophe, they saw little to no trading in the debt markets in anticipation. Uncertainties still run high, and many investors believe a compromise will eventually be found, a complacency Ms. Misra sees as misplaced.

“The political situation is similar,” she said, “but the financial markets are much less liquid.”

There is a new precedent for a meltdown. Trading in the Treasury market collapsed in 2020 at the start of the coronavirus pandemic as investors quickly sold some types of government bonds, setting off a chain reaction of asset dumping, a chaos that was only stopped by Fed intervention.

If markets experience another disaster from the debt ceiling debate, the Fed could once again mitigate the damage. Central bank officials plotted a possible default in 2011 and 2013, and the minutes of those meetings paint a rough, unappealing playbook.