Debt deal deals blow to QE tapering – USD in

18

The US dollar is on the fall after the US government has finally reopened and the debt ceiling deadline has been postponed.

The temporary nature of the deal, and the potential for more headwinds for the economy, point to another delay in QE tapering, perhaps way into the distant future. Don’t blame China for this one.

Dagong!

Headlines are pointing to Chinese rating agency Dagong as the culprit: it downgraded the US credit rating. While China holds a significant chunk of US debt, this downgrade, together with the tough talk from Beijing before the resolution, led some to think that China would unwind its US debt, thus putting pressure on the US dollar.

However, Chinese rhetoric isn’t where Chinese action is: there are no signs that China is going to sell US bonds en masse. They don’t have too much of a choice. This seems like an opportunity to deal political blow to the US on the weak deal – countering criticism of currency manipulation that has been heard repeatedly in the US.

Fed Ahead of the Curve

The biggest force in the foreign exchange remains the Federal Reserve. Hints about QE tapering in May and in June strengthened the US dollar and hit emerging markets, stocks markets and the global economy. The decision not to taper bond buys in September hit the US dollar and cheered up stocks and emerging markets.

And why did the Fed refrain from tapering? It’s the economy. They needed more evidence for a sustained economic recovery and also mentioned the headwinds coming from the government.

The headwinds proved to be worse than what was imagined: the US government was shut down for no less than 16 days and politicians reached a deal just before the debt ceiling was about to hit and just before the US could have defaulted on its debt.

Sequester Sequel

There is quite a lot of damage already done by the shutdown (estimated at $24 billion) and a lot of damage in the US image and credibility.

The bigger issue is: it’s not over. The government has less than 3 months to remain open (January 15th) and the debt ceiling is set to officially expire on February 7th. With some luck and accounting acrobatics, the debt ceiling could remain untouched until mid March.

The short term nature of the deal leaves global investors worried, and also the Fed could stay in a “wait and see” mode.

When the Fed was talking about fiscal headwinds, it was referring to the sequester that came into effect back in March. Not only are the spending cuts (which weren’t expected to happen when agreed upon in August 2011) still with us, but a second wave of automatic cuts will come into effect in mid January, together with the potential government shutdown.

QE-Infinity

Of course, US politicians could theoretically work hard and cut a deal. There is time. Yet given the past debacles and the holiday season, a new crisis is quite a safe bet.

On this background, the Fed isn’t likely to taper bond buys in October, not in December and not in January. The $85 billion / month bond buy program will probably be inherited to Janet Yellen.

The QE program, which looks infinite, is the major reason for dollar weakness.

Dagong hit the US with gong, Fitch could send the dollar to the ditch, and Moody’s can sour the mood. But, these are short term storms.

The Fed determines the long term trend of markets, and its ongoing QE weighs on the dollar. Rating agencies have a short term effect on markets, ongoing printing has a bigger effect.

The Fed stayed ahead of the curve in September, and has no reason to change its mind.

Further reading: A Stop Gap Debt Ceiling Solution Would be a Drag for USD

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About Author

Yohay Elam – Founder, Writer and Editor I have been into forex trading for over 5 years, and I share the experience that I have and the knowledge that I’ve accumulated. After taking a short course about forex. Like many forex traders, I’ve earned the significant share of my knowledge the hard way. Macroeconomics, the impact of news on the ever-moving currency markets and trading psychology have always fascinated me. Before founding Forex Crunch, I’ve worked as a programmer in various hi-tech companies. I have a B. Sc. in Computer Science from Ben Gurion University. Given this background, forex software has a relatively bigger share in the posts.

18 Comments

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  6. In the latest deal, Obama changed the law where raising the debt ceiling could be denied with a house majority to needing both house and senate majorities to deny the request. Since Dems are unified in the senate…there is really no threat of another short term debt crisis but plenty of room for more long term damage.

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