There is every sign that the debt ceiling car crash in the US is looking pretty much inevitable now. Overnight, even Republicans were failing to agree amongst themselves on their two-step plan to increase the debt ceiling and then enact a number of spending cuts. This is also the plan that is strongly opposed by the White House, not least because the USD 1trln increase in the debt ceiling would require another extension in the early part of next year as the US enters the Presidential election year.
The market reaction has been further dollar weakness. The dollar index is just 0.7% off the lows for the year and it would only have to depreciate another 3.9% to reach an all time low. EUR/USD has maintained its move above the 1.45 level and AUD/USD has smashed through the 1.10 level after the stronger than expected CPI data.
Guest post by FXPro
Commentary
Australian inflation surges in Q2. The quarterly inflation release showed headline prices rising by 3.6% YoY, up from 3.3% and beating expectations for a modest tick higher to 3.4%. Part of the firmer outcome was put down to the impact of the floods earlier in the year, but the data nevertheless placed the prospect of higher rates back on the agenda. Only a couple of weeks ago there was talk of the next move being a decrease in rates. The Aussie reaction has lifted the currency to a new record high vs. the dollar – above the 1.10 level.
US consumer confidence higher. The main consumer confidence data unexpectedly rose in July, up to 59.5 from 57.6 previously. This went against expectations of a further modest decline. The expectations balance increased whilst participants’ views on the present situation fell a touch. Still, the cut-off data for responses was the middle of the month, at a time when participants were probably a lot more hopeful of a deal on the US budget situation than they are now. As such, the data should be taken with a pinch of salt for now. The New Home sales data showed a decline of nearly 6% so far this year, with sales still more than 75% down from their 2005 peak.
Debt focus shifts from markets to economy. Despite the weaker dollar during Tuesday, markets have so far largely been the dog that has not barked when it comes to the impact of US default. Bond yields are higher, but only marginally so. This is despite the fact that the likelihood of a debt limit deal being signed, sealed and delivered by next Tuesday is looking slimmer by the day. The focus is now shifting to the impact on the economy of a government unable to borrow in the markets but struggling to pay the ongoing interest on its debt. In this situation, with the spending on entitlement programs and debt interest continuing, a government would try and struggle on for some weeks by cutting spending where it can in other areas, funding this only via what it receives in taxes. The trouble is that there’s not much, if any, leeway to play with. Around 40% of spending is due to be financed by borrowing this year, yet Medicare/Medicaid, social security, interest payments and other mandatory spending account for just over 60% of total spending. So, if discretionary and defence spending fell to zero, then things would just about balance out, but naturally that’s not a realistic scenario. A federal government trying to battle down the path of surviving on a balanced budget would push growth into negative territory. This would occur at a time when the economy is also in a fragile state, with employment still significantly below the pre-crisis peak and overall output only having just risen above it. Furthermore, this would counteract the upward pressure on yields from the inevitable downgrade which could serve to mute the overall financial market impact.
UK growth weak but blame it on the boogie. The UK economy grew only 0.2% in the second quarter, but fret not, for the Office for National Statistics has blamed it on the sunshine (not the moonlight), the good times and the boogie (extra holiday for the royal wedding in April). Were it not for these one-off factors, then growth would have been around 0.5% stronger. Whilst sterling breathed a mild sigh of relief at these numbers, they don’t change the underlying picture perhaps as much as the market believes. With the government sector flat on the quarter, production falling and only a modest increase in construction, it was the services sector that was the only real driver of the economy during the first quarter, total services rising 0.5% QoQ, vs. the 0.2% increase in the total economy. Four months after the budget, achieving the growth profile envisaged by the Office for Budget Responsibility (OBR) looks pretty impossible. The economy would have to grow by over 1% in the coming two quarters if the 1.7% growth projection is to be achieved. By all accounts, this looks pretty unlikely. Even a doubling of the pace of growth vs. the first half would only achieve 1.4% for the year as a whole. This likely shortfall, together with the ever-growing focus on the fiscal side in the eurozone and the US will ensure that the coalition will come under increased pressure regarding its austerity plan and lack of a ‘Plan B’. The GDP data may serve to be the writing on the wall for Osborne.
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