Stocks surged and the US dollar got its mojo back overnight after the Republicans finally offered an olive branch with a 6-week temporary debt ceiling rise.
The White House called this encouraging but it doesn’t seem that the shutdown will end.
Even though the protagonists now seem to be talking to each other rather than throwing barbs, all this really does is take a deadline that everyone has known about for 6 months and kicked it down the road 6 weeks.
Yesterday the Westpac FX Strategy team released an FAQ on the debt ceiling.
Is the government shutdown now old news?
The US government shut down for 1 to 3 days on 9 occasions between 1981 and 1990 so there was initially some hope that this episode could be similarly brief. However, in its 10th day, the current shutdown is the second longest since 1978, exceeded only by the 1995-96 closure. Having lasted this long, it seems quite unlikely (though not impossible) that there will be a separate deal to reopen the government before turning to the debt limit. This suggests the partial shutdown continues into early next week at least, to finally be resolved by agreement on both reopening and raising the debt ceiling.
Is 17 October really the debt ceiling deadline?
The US actually hit its $16.7 trillion debt limit in May. Since then it has been employing a range of “extraordinary measures” to avoid net new borrowing that would breach the limit, given that of course the budget is still in deficit (about -4% of GDP, versus a GFC peak around -10%). These measures have raised about $300bn but Treasury says its spending and revenue projections point to the government being no longer able to pay all its bills on time from 17 October…
Indeed there is no interest payment due until $6bn on 31 October. Before then, Treasury projects it will struggle to meet payments including Social Security and Medicaid. Part of the lack of urgency to make a deal on the Republican side comes from scepticism over the 17 October deadline.
Can the US avoid default by prioritizing interest payments?
The White House and Treasury are obviously keen to stress the importance of 17 October and brush off suggestions that Treasury can pick and choose which payments to make, thereby avoiding default…It is difficult to see the government delaying payments such as Social Security and Medicaid for very long, let alone in order to pay bondholders first – the public backlash would be severe. Any attempt to defer some payments to ensure bond holders are paid in full would entail a drastic cut in federal spending, sending the US in all likelihood into recession.
Is there any other threat to treasury markets?
No less than $302bn in longer dated treasury securities matures in the second half of October. Rolling these over at auction could be a real test of investor demand if the debt ceiling still has not been lifted. Obviously rolling over this sum does not increase the total debt subject to limit. No one can say precisely when the Treasury will completely exhaust its cash reserves – not even the Treasury, given that revenue inflow will always be subject to a certain amount of random volatility. There is thus a strong focus on key payment dates for the Treasury in the days and weeks after 17 October that might constitute “crunch time”:
What are the key dates?
17 Oct: Treasury’s estimate of when its “extraordinary measures” will no longer cover net outflows. Also $120bn in treasuries matures
23 Oct: $23bn in Social Security benefits due
24 Oct: $93bn in bill maturities.
31 Oct: $6bn interest payments due on public debt. Also $89bn in bill maturities and $61bn of note redemptions (according to Bloomberg).
Absent prioritizing bills coming due, the schedule is such that $30bn is likely to be exhausted no later than end-October / early November according to most analysts.
How might a deal be reached?
What does this all mean for AUD?
…in a nutshell, our view is that the risk environment is likely to get worse before it gets better, capping AUD/USD near 0.95 and with substantial risk of a large pullback to say a 0.92 handle if the sides are still facing off beyond 17 October. Indeed in terms of galvanizing politicians to make a deal, it is worth remembering that in Sep-Oct 2008 it took a -8.8% crash in the S&P 500 when Congress rejected the Treasury proposal to buy troubled assets (TARP) to prompt a re-think. If market stress is limited mostly to money markets then defiant House members may not feel the urgency to make a deal. However, AUD/USD should participate in any relief rally (back towards 0.95 multi-week) once a deal is struck (perhaps just ahead of the 23 Oct Social Security payments). However this crisis is resolved, it will add to the current drag on growth from fiscal policy. Hence the Fed seems likely to maintain QE at full pace until at least Q1 2014, undermining USD/majors.
What is the political backdrop for a deal on raising the debt limit?
The Republican terms for a deal on raising the debt limit seem much broader than their terms for reopening the government. The latter has focused mostly on the ACA – defunding it or delaying it for one year. It is not yet crystal clear what the Republican quid pro quo for a higher debt limit revolves around, but at the very least many have suggested it will include cuts to entitlement programs and tax reform. Their price for a higher debt limit may or may not yet include another attempt at gutting the ACA as well. The uncertainty is that many House Republicans aren’t yet sure of their strategy – many moderates in the party would prefer simply to pass a “clean” bill to reopen the government and raise the debt ceiling.
Congressional Democrats baulk at the idea of a “grand bargain” but the White House is open to the conversation, representing yet another fault line.
This morning, US stock markets are up around 2% overnight and hope is that the parties are coming together, but as Westpac notes, there are still a number of fault lines that might just open up even in the 6-week hiatus and there is no guarantee that stocks and the Aussie dollar won’t once again come under pressure.
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