FYI | Oct 16 2013
By Kathleen Brooks, Research Director UK EMEA, FOREX.com
That is the question that the US Congress is trying to resolve this week. With just two days to go optimism is high that a deal will be reached. The Senate are putting together a deal to raise the debt ceiling that could last until February and to re-open the government until the end of the year. This is not a perfect outcome, essentially it is merely can-kicking, however it is better than having to deal with the US’s fiscal problems in two days’ time. The House Republicans will meet later this afternoon to debate this latest plan, until then we expect market sentiment to remain positive in anticipation of a resolution to this crisis.
[As it turns out, a resolution has not been reached. The gap is nevertheless closing, suggesting the typical eleventh hour concession most are expecting is still on the cards – Ed.]
A bullish bias in equities
Equity markets have been fairly resilient to the US fiscal stand off and have shown a remarkable ability to rally at only a hint of good news; for example last Thursday’s thundering rally by the bulls after the Republicans entered talks with the President, although those talks eventually came to nothing. This suggests to me two things either: 1, the market does not believe that the US will default, and this impasse is actually good for markets as it prolongs QE from the Fed, or 2, the market is focusing on strong earnings data for Q3; however political concerns could limit earnings in future quarters.
The US cries wolf yet again
Looking at the first point in more detail, the market may be developing immunity to US political wrangles after reports that the notion the US has never defaulted on its obligations was challenged by a number of media publications. The Treasury was late in redeeming T-bills in 1979, which was blamed on an unanticipated failure of word processing equipment to prepare the repayment schedules. The Washington Post reported that the US defaulted after the Revolutionary War, and a Chinese rating agency has accused the US of defaulting already by allowing the dollar to weaken against other currencies. Thus, the US has a history of shirking its liabilities while managing to avoid a technical default.
The US won’t default
It looks like history may repeat itself. Although the US debt ceiling was actually hit back in May, the Treasury was able to use extraordinary measures to keep the government funded up until October 17th when the extraordinary measures run out. However, even if we pass through October 17th without a deal that need not mean financial Armageddon as the President can invoke the 14th Amendment and continue issuing debt even without a deal from Congress, alternatively the Treasury could sell “super-premium” long term debt with extra-large coupons, while cutting T-bill issuance, thus circumventing the “no borrowing” rule. Although the latter option is probably less controversial than the President going out on his own to issue debt, super-premium bonds are an expensive way to get out of this fix.
November 15th is the real D-day
Essentially, this means that the US has time to play with even if there is no resolution by October 17th. This could be placating the markets for now, however if there is still no deal by mid-November that is when the proverbial could truly hit the fan. The US has a $31 billion interest on debt payment due on 15th November and even the US Treasury could find it hard to shirk a payment of this size.
So from a ratings perspective the US may be safe from a default or even a downgrade in the near term, but the reputational damage that may be a consequence of the stand-off in Washington could have a long –term detrimental impact on the dollar and other US assets.
The USD as a reserve currency – under threat?
On that note, the Chinese renminbi reached another record high versus the USD on Monday; although it is far too premature to think that Beijing could be planning to liberalise its currency and try and usurp the US as the global reserve currency, China has been increasingly losing patience with Washington, so watch this space.
UK: sticky price pressures have no impact on GBP
Although the focus remains the US and the outcome of the debt ceiling negotiations, outside of Washington, the macro focus this morning has been on UK CPI and German ZEW. UK prices were stronger than expected, staying at 2.7% for September, rather than declining to 2.6% as the markets expected. The largest upward contribution came from air fares, even though petrol and diesel prices fell. House prices were also stronger than expected for August, rising 3.8% YoY. Although rising prices could be considered GBP positive as it pushed QE from the BOE even further onto the back burner, the focus today is on the US and the potential for a resolution to the US debt ceiling issue. Hence, after an initial spike to 1.60, GBPUSD has fallen back sharply to below 1.5940, the bottom of the most recent range is 1.5915, which could act as key support.
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