Debt limit default 'will have substantial ramifications' on economy, markets: Strategist

F/m Investments CIO Alex Morris sits down with Yahoo Finance's Julie Hyman to discuss the impact of the debt ceiling on markets, treasury demand, and purchasing treasuries from TreasuryDirect versus ETF.

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RACHELLE AKUFFO: Right now, over to Julie Hyman in our New York studio. Hey, Julie.

JULIE HYMAN: Well, it's a red kind of day, isn't it, Rachelle? Lawmakers say a compromise on the debt ceiling is possible this week. But a deal does not mean the market will emerge unscathed. Just look back to 2011. A serious credit showdown during the Obama administration spurred a US credit rating downgrade that hit treasuries hard.

FM Investments is a $5 billion multiboutique investment advisor based in Washington, D.C. It recently launched a suite of US Treasury ETFs with the goal of simplifying investor access to treasuries. And with me now is Alex Morris, FM Investments CIO. Thanks for being here.

ALEX MORRIS: Thanks for having me.

JULIE HYMAN: It is a very interesting time in the Treasury markets. I guess it has been, really, this year. But let's talk about the debt ceiling, specifically, because this is one of the few areas of the market that does seem to be a little bit more reactive to the debt ceiling debate. What do you think we're going to see unfold in the Treasury market.

ALEX MORRIS: Well, I think we've seen the one-month go to levels no one thought it would. And if you look at the yield curve today, it's less of a curve, more of just a bumpy road, which is a good indicator of what's happening in DC.

But ultimately, this gets solved. I mean, it happened in the Obama administration. It's happened every time before. The question is, how much damage do we do to the economy or to the Treasury market between now and then? But ultimately, this will find a resolution, whether it's removing the debt ceiling altogether or pushing the limit substantially higher. In the short run, it's like running a money market fund. They say it's 99% boredom and 1% sheer terror, and now we're in that bit where we wonder, God, is this what it comes to?

But I think in the short run, we'll see some more rockiness, but ultimately, the one-month will calm down, and this will get resolved.

JULIE HYMAN: What about the damage, though, that you referred to? You guys recently wrote a paper where you sort of dug into what could be the ramifications.

ALEX MORRIS: So the short run is what will we not pay if we can't do this by June 1, and whether it's June 1 or June 3, we have to call it June 1 because politicians need a good deadline. And along that, someone's not going to get paid. I just don't think that's going to be the US bondholder. Ultimately, defaulting on the debt would have substantial ramifications. But some vendors might not get paid. I mean, every few years, the government threatens a shutdown and stops paying employees but then three weeks later pays them back.

So there's a lot of tools at the disposal that will be used, but I don't think the first reaction is going to be let's stop paying the bedrock of the US economy, the US Treasury note.

JULIE HYMAN: And sort of over the longer term this year, given the dynamics of the Fed, whether it's going to pause or not as of its next meeting, what is the sort of underlying demand for Treasuries continue to look like? We've seen retail enthusiasm that we haven't seen during, certainly, my investing lifetime as of late. Is that sustainable?

ALEX MORRIS: I think for the next year or so, it probably is sustainable. I mean, if you've been investing for a long time and knew the rule of 4%, you're trying to get a 4% yield. And if you can get that from the Treasury markets with no concern for the next year and a half, why would you not take the free lunch?

That said, at some point, rates will come down, and duration will be interesting again. And it turns out the average retail investor doesn't do well playing in the middle and long end of the curve. So we'll see some of that demand go back and probably back into equities and growth equities, where the returns are much juicier.

JULIE HYMAN: Now, I don't know how limited you are in talking about the ETF specifically, but I am curious about an ETF Treasury offering versus people can do TreasuryDirect now, right? They can go straight to the US government and buy Treasuries. So what are the sort of various advantages and disadvantages of doing it one way or the other?

ALEX MORRIS: Sure so I encourage anyone who wants to buy from TreasuryDirect to go and try. The website is a little buggy. It crashes, and it gives you the full menu of options that the government offers. And it's an awful lot. And once you have it, you're going to hold that to maturity.

Most folks want to buy something and want to know they can sell it easily for a fair price right away. And that's the series that we do. So if you take a look at the 90-day, there are a lot of 90-day, notes whether it's a 30-year note that's almost expired, or a one-year note that's 3/4 away through its life, or the one issued last Tuesday, what do you want to get?

We provide you access to the most liquid one, which is that most recently issued. And that's what TBIL does. You'll get your income. You get a monthly income stream as opposed to waiting 90 days to get paid. And if you decide that you have something else you want to invest in, it's just as easy to buy and sell versus waiting or trying to now sell it out of TreasuryDirect, which is much more complicated.

JULIE HYMAN: Alex, thanks for being here. Interesting stuff, and hope to talk to you again, as we see all of the debt ceiling and Fed stuff unfold over the course of the year. Thank you.

ALEX MORRIS: Thank you.