Keith Mullin, Editor at Large, International Financing Review
I’ve avoided writing about the US debt ceiling impasse until now, assuming the petty politicking would get sorted out in good order and I’d then focus on the resulting impact and outlook. Now that the Greek debt furore has died down somewhat, (though not by any means gone away; read my column from last Friday), the US issue has got the attention of pretty much everyone now. As US Treasury Secretary Timothy Geithner put it on TV over the weekend: “The eyes of the world are on us”.
Indeed. And what a pathetic tale it is. I don’t profess to be familiar with the under-currents of US politics. Nor do I follow closely the daily cut-and-thrust, but I don’t need to. This is a tale of silly men (mainly) playing dangerous games of brinkmanship with the US and world economies. It’s unnecessarily creating market distortions – stocks and dollar down; gold, Swiss franc up – as people try to figure out what the deal’s going to be, how it impacts US Treasuries and every other traded market out there, what happens to funding markets, and how to position depending on which eventuality finally emerges.
No-one knows what to do because the prospect of a US default takes us into uncharted territory. Regardless of what happens, though, it probably makes sense to stay exposed to quality US assets. One saving grace for the US, which always underpins its government bond market, is the status of the US dollar as the world’s reserve currency, the absence of any other similarly liquid dollar financial asset, and a glut of global liquidity. These elements will likely make what’s still referred to somewhat ironically as the ‘risk-free asset’ perform through this saga.
As for the deficit-reduction plans being proposed by the warring parties, I must say – and please note I do so as a market watcher with zero political intent or bias – Boehner’s plan to raise the debt ceiling in two phases (one through the end of 2011 and a second in January 2012 depending on a congressional commission’s deliberations on taxes and spending programmes) looks messy. It means the issue will be with us for months, followed by a huge amount of additional political wrangling, followed by months more of uncertainty. We had all of that with Greece; it was interminable and tedious in the extreme.
A deal that takes the US through to the end of 2012 (notwithstanding it gives the Democrats a free ride to the elections, which I don’t’ care about in my political neutrality) sounds on paper like a better plan for markets, which hate uncertainty.
So what of the immediate impacts? Is China seriously re-thinking its investment strategy with a view to lightening up on its US$1.226trn in US Treasury holdings if the US is downgraded or can’t reach an agreement? It certainly doesn’t look like it’s on the agenda, though Chinese officials are closely scrutinising developments and have made their feelings about the situation crystal clear to their US counterparts. Ditto Japan with its US$912bn of US Treasuries. (Between them China and Japan account for 45% of foreign holdings of US Treasuries).
The US parties will cobble something together that will prevent missed payments as they seek to safeguard the nation’s coveted Triple A rating. But will a hastily pulled-together deal provide a long-term credible solution? Clearly not. So the question then has to be: should the top rating therefore be safe? In the eyes of many analysts, no. Some are expecting a one to two notch downgrade as early as the end of the summer, certainly by the end of the year as the parties continue bickering on a credible outcome.
What of the fear and panic among market participants and their supposed Armageddon planning? I must say there hasn’t been much evidence of panic in today’s trading. Safe-haven positioning? Sure, but even then on reduced liquidity as market players choose to sit it out on the sidelines. I reckon those recounting the concerns of global investors are over-playing their hand. Cards on the table: does anyone deep down, seriously expect the US to pass deadline without a budget deal, without agreement on the ceiling and default on debt payments? I find it hard to buy such an outcome.
The Battle of Armageddon, let’s remind ourselves, is where the Messiah returns to Earth to defeat and cast the Antichrist into the abyss (the same abyss, incidentally, that financial market commentators and analysts also over-reference in metaphor). I’ll leave it to the US ideologues out there to cast Republicans or Democrats in whatever role you deem fit in a re-run of that fabled battle – that’ll take your mind off the tedium of the daily shenanigans.
The disaster card has been played all too often since the 2008 financial crisis, and has been trotted out a few times over the past few weeks to describe market reaction to a failure of US policy. Bottom line: a disorderly sell-off leading to a de novo financial crisis prompted by this issue looks unlikely at this point. More tomorrow.