Its a well-known fact that investors and financial markets hate uncertainty and seek stability and its also a fact that politics is about ambiguity and last-minute compromises, says Swiss & Global Asset Management’s Head of Investment Management and the debate about the US debt ceiling, however, has crossed a line and clearly shows that current political forces are struggling to responsibly govern the country with the worlds benchmark bond market and reserve currency.
“The US debt deal is still in disarray [but] has had only limited impact on global financial markets so far,” says Stefan Angele, Head of Investment Management at Swiss & Global Asset Management.”There is still a chance that an agreement to raise the debt ceiling is reached just ahead of the deadline. But the bulk of key decisions on fiscal tightening will almost certainly be delayed, probably until after the 2012 elections. If no timely agreement is reached, the near-term impact for financial markets could be significant volatility.”
Angele says that risk aversion would spike, the US dollar would probably be hit and the short end of the US bond market might be hurt as these yields rise disproportionately more than longer maturities. Longer yields might even fall in anticipation of a negative GDP impact (which is estimated to be around -0.5% for every month that the debt ceiling is not raised).
However, Angele says that there would be still a good chance that the lapse in borrowing authority might only be brief and would hopefully be resolved prior to the Treasury coupon payment on 15 August.
“Still, from the date after which the US Treasury will no longer have sufficient cash to pay all of its bills (estimated between 2 15 August), government spending must be cut sharply and payments must be prioritised to avoid a debt default as bills can be paid solely out of incoming cash flows,” says Angele. “Also, the US Treasury has never failed during a debt limit impasse to meet any payment obligation. Even during the government shutdown of 1995/96, mandatory spending continued without interruption and only non-essential services were suspended.”
“In the very unlikely case that the US government ultimately has to default (and public spending would presumably be cut massively and the economy would fall back into recession), the global implications would be serious since US government debt is held as a risk-free asset in banks or insurance companies,” he adds.
(LB)