U.S. default seen as buying opportunity

The risk of America technically defaulting on its debt is increasing rapidly, with the odds of such an event rising to 1 in 5 as a result of political bickering south of the border.

That’s the view of Jack Ablin, chief investment officer of BMO Harris Bank in the U.S., who said the risk was less than 5% about two weeks ago.

Read: No movement in U.S. debt stalemate

“We’ve got the rating agencies rattled, we’ve got investors rattled,” he said in a conference call on Thursday morning. He pointed out that S&P and Moody’s have already put the U.S. government on notice.

“Keep in mind, most of these ratings agencies were caught flat-footed and accused of being co-conspirators in 2008,” he pointed out. “They have come out much more aggressively now, so my sense is we’ll hear a lot from the ratings agencies. It’s entirely possible the U.S. could face a debt downgrade in the next couple of weeks if nothing happens here.”

Ablin says the most likely scenario is Senator Mitch McConnell’s plan to hand authority over to the White House, allowing the government to avoid default while providing the Republicans with political cover.

But even if the U.S. does default on its debt, Ablin sees a buying opportunity.

“We don’t believe [the U.S.] would miss an interest or principal payment, provided the issue was solved in a period of three to five business days,” he said. “Secondly, it would rattle the equity market enough to create an interesting opportunity to add risk.”

In the meantime, nervous investors might want to shift some of their commodities holdings into gold.

Shifting fixed-income assets into multinational corporations could also shield against a default, as these companies theoretically have the option of moving their head offices overseas to avoid the fallout from the debt crisis.

The most bearish investors may want to short Treasuries using an instrument like the ProShares Short 20+Year Treasuries ETF.

“In my view, this is a contrived crisis. This isn’t calling into question [America’s] ability to pay; it’s really a question of willingness,” Ablin said. “The most likely outcome is some sort of punt, where we expand the debt ceiling and not solve the tough issues.”

There has been some talk that Canada is increasingly seen as a safe haven for investors seeking shelter from a possible U.S. default. It would not take a large percentage of investors leaving the U.S. Treasury market for Canadian bonds to have an impact on the loonie. But Ablin thinks a U.S. default could have the opposite effect, since the Canadian dollar tends to be a “risk-on” trade.

“There is a decent chance that if we get a technical default, we’d see the Canadian dollar get hammered,” he said. “It’s a commodity currency tied to near-term global economic expectations. On a purchasing power basis, the Canadian dollar is trading about 8% too expensive to the U.S. dollar.”

Paul Taylor, CIO of BMO Harris Private Banking in Canada, says the coming quarter will be choppy for Canadian investors. While he believes the underlying trend of global expansion and strong demand for commodities is in tact, the sovereign debt issues on both sides of the Atlantic pose serious threats to that growth.

“We are in the process of de-risking our portfolios to a more moderate stance in equities,” he said. “We believe there are very important macro risks that will weigh on capital markets. A negative outcome in the U.S. debt and deficit discussions could have relatively serious implications for equity markets.”