No US debt agreement in sight

illustration: DNB markets dealingroom

(25.07.2011) A divided US Congress is still not closer to reaching a deal regarding the US debt ceiling. This morning Moody’s decided to downgrade Greece’s government debt.

By Anders Grøn Kjelsrud, Analyst at DNB Markets

The debate regarding the US debt ceiling, a self-imposed limit on how much debt the US government can undertake, continues with full strength. The current limit of USD 14.3bn was reached sometime in mid-May, and the Treasury has since then been forced to used “accounting tricks” to settle their obligations. According to the same Treasury, this will no longer be possible after 2 August.

The upshot will be large, abrupt and unfortunate cutbacks in public spending. Even thought rising the debt-ceiling usually is only a formality, the two parties have made it to a debate of the long-term US financial challenges. The Republicans refuse to raise the ceiling as long as they do not get support for a long-term savings plan without tax increases, while the Democrats for their part want a savings plan that combines spending cuts with tax increases.

President Obama seems to have taken a kind of middle role, where his clearest message has been that a temporary solution is not accepted – the increase in the debt ceiling must be large enough to avoid a new fight until after the elections next year.
 
The negotiations between Obama and the Republican House speaker John Boehner broke down Friday night, after Boehner refused to participate in further negotiations – after Obama had offered what himself refers to as an “extraordinary fair deal”. The intense discussions have resumed during the weekend, but there are still no signs of an agreement. And now the US politicians are beginning to run out of time, with the Aug. 2 deadline for approval in the Congress only little more than a week away. For now it appears that financial markets believe that the conflict, which in principle can lead to an US default, will be resolved in time. Admittedly, the news of Friday’s break in negotiations came after the markets closed, so we can not entirely rule out negative reactions when the markets open later today. Asian stock prices have fallen somewhat tonight, while the US dollar has remained fairly stable versus the euro in FX.

The debt crisis in Europe is another major factor for financial markets currently. As known, the euro strengthened quite significantly versus the dollar Thursday afternoon, after leaks of a euro zone agreement of a new Greek rescue package. The tendency of relief was even more apparent in bond markets: Yields on the most indebted European countries’ government bond fell significantly – the yield on two-year Greek bonds by as much as 13-14 percentage points (albeit to still soaring 27 per cent).

However, the relief-rally lost some of its momentum during Friday’s trade, and the euro weakened slight versus the dollar. EURUSD is currently traded around 1.43-1.44. Time will tell if Thursday's bail-out is enough to calm the financial markets going forwards – experience from the previous bail-out packages shows that relief suddenly could be turning into new unrest.
 
Early this morning Fitch announced that they have decided to downgrade Greek government debt from CAA1 to CA, one notch above what is considered as default. This should come as no surprise.  Furthermore, the rating agency says that the support package increases the likelihood of a reduction or stabilization of Greek public debt, but the medium-term solvency problems are still considerable.
 
The present week contains very few interesting macro publications. British GDP figures for the second quarter are released tomorrow, the same day as the Conference Board publishes its US consumer confidence index. The weekly highlights come first on Friday, in the form of US and Swedish GDP figures, as well as new CPI figures from the euro zone.