Testing the Full Faith & Credit of the US

<p>Markets turn their glare to Washington where partisan squabbles threaten to undermine the US economy once again. Congress has until Monday to pass a budget […]</p>

Markets turn their glare to Washington where partisan squabbles threaten to undermine the US economy once again. Congress has until Monday to pass a budget or a government shutdown will begin. At best, it looks as though some sort of provisional bill will kick the can. Democrats are taking a hard line on Obamacare and some Republicans are in no mood for compromise.

As traders evaluate the seriousness of a possible government shutdown next week and a debt limit crisis by mid next month, the latter is definitely the more serious concern. A government shutdown would not necessarily halt Social Security payments, but a debt limit crisis could do so, as well as stop veterans benefits, Medicare and Medicaid reimbursements.

The US Treasury has set October 17 as the date when the debt ceiling would most likely be breached. Treasury Secretary Lew said:  “If we have insufficient cash on hand, it would be impossible for the United States of America to meet all of its obligations for the first time in our history…the results could be catastrophic.”

While this may be viewed as just another crisis that will be solved in the last minute, the impact remains significant. The permanent loss of income for nearly a million government workers, already hit by sequestration, and paycheque delays to larger group by October 15 would weigh on consumer demand and retailers anticipating Thanksgiving and Christmas activity.

Central Banks doing their Part

The looming crisis is giving the “full faith and credit of the United States” a run for its money. Despite the repercussions, the cost of US debt has remained exceptionally low due to the Fed’s insistence on capping bond yields. Last week’s surprising decision to maintain the $85 bn in monthly purchases intact will give the nation more time in keeping rates low. The Bank of England is also playing its part via MPC members’ latest speeches. So is the European Central Bank via reiterating its forward guidance of a “really low” bias on interest rates. In Japan, we haven’t heard of any more remarks regarding asset purchases, but the Cabinet is so far alleviating global markets by circulating renewed reports on cutting corporate taxes in order to offset next year’s sales tax hike.

Considering the deepening fiscal limitations of the US and the locked-in situation of QE3 from the Fed, the FX dynamics will continue supporting EURUSD above 1.3450, GBPUSD above 1.5900 and AUDUSD at 0.9270.

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