After House Speaker John Boehner (R-Ohio) abruptly withdrew from the debt talks with the White House last Friday, the latest development is the dueling proposals from the Republican leader in the House and Democratic leader of the Senate to hopefully get the federal $14.3-trillion debt ceiling lifted.
Nevertheless, Lawmakers remain at odds over how to avoid a debt default. With a fast approaching Aug. 2 deadline, the impasse saga at Washington only serves to sharpen the image of an unprecedented U.S. sovereign default into HD 3D.
Investors’ fear and worries over the potentially devastating default have tanked the equities and commodities, while gold hit a record of almost $1,620/oz. Rather than the conventional risk-off trade–“sell commodities, buy the dollar”– investors threshed the dollar, but still have faith in the U.S Treasury.
The U.S. dollar has lost 7% year-to-date, while Treasury has not seen as much pressure, considering the debt fiasco (See Charts Below) Typically, when investors sell the dollar, it pressures the U.S. bond market as well.
Part of the dollar weakness has to do with lots of forex players coming into the market just to short the dollar. Another factor in the diverging behaviours between the currency and bond markets is that more and more people believe the probability of a U.S. sovereign credit downgrade is a lot greater than that of a total debt default. The resilience of the U.S. treasury is also is a clear indication that the bond market expects the debt ceiling will be raised before the August 2 deadline.
Major rating agencies, including Moody’s, S&P and Fitch, have warned of an imminent downgrade if Washington fails to pass the debt ceiling, which could result in an interest rate spike for the federal and state governments, corporations, and individuals.
JP Morgan estimated that a U.S. credit-rating cut would likely raise the nation’s borrowing costs by increasing Treasury yields by 60 to 70 bps over the “medium term,” adding $100 billion a year to government costs while dragging down economic growth.
At the same time, despite a long-term debt and deficit problem, fundamentally, the United States currently does not have an immediate solvency issue. When push comes to shove, people still flock to the U.S. Treasury for safety. So it is really of grave concern that the government of the world’s largest economy would let a political soap opera become a short-term crisis to its currency, markets and not to mention the nation’s image and reputation.
Some have said that the Fed and Washington want the value of the dollar to plummet so the nation’s debt many be repaid in cheaper dollars. Perhaps all this debt ceiling mess is just part of the grand design? If so, then pretty soon, these Art of Defaced US Dollars would be worth more than the real dollar.
Read more posts on EconMatters »