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Now that the dust has settled upon the furore that has surrounded the FOMC’s decision regarding whether to begin tapering the current $85 billion of asset purchases, the markets are likely to take stock and aim their attention to the next crisis.

America being America, there happens to be one just around the corner, with the impending need to ratify a spending bill and extend the current debt ceiling.

Sequester  

Should these events remain unresolved, the first to hit would be the issue of the impending sequester, which is required prior to the commencement of the new fiscal year which starts on 1 October. In a perfect world, the issue would be resolved by both the senate and House agreeing on mutually satisfactory appropriation bills for 12 different areas. These would cover areas such as defence, healthcare and the judicial system. However, America doesn’t work like that while the senate (Democrat) and House (Republican) are controlled by the separate parties. The core dividing line between both parties on this occasion is centered around President Obama’s controversial healthcare programme.

The desire from each side is clear. The Republicans, as usual, seek to reduce the level of spending currently in place, and on this occasion it is the healthcare spending which is in the firing line. House speaker John Boehner has bowed to pressure from the more hardliner conservatives, deciding to now put forward a proposition that would keep the government funded for another 2 1/2 months, yet fails to cover any health law funding. However, Barack Obama has simultaneously declared that there would be absolutely no concessions made to pass the current budget, stating that the economy would not be held to ransom by brash republicans. Either way, you can see why the FOMC decided to delay tapering, citing potential threats from ‘fiscal retrenchment’.

Debt ceiling

The second topic of note is the debt ceiling which caps the level of debt the treasury is allowed to preside over. The current cap is at $16.7 trillion and at the current rate of growth, the US spending looks set to reach that level by mid-October. The debt limit can be seen in one of two ways. Firstly, it could be resolved with relative ease given the knowledge that there is a possibility the Republicans could obtain some concessions in relation to health care cuts during the spending bill discussions. On the other hand, this may be saved as a method to ensure that should their first bite of the cherry not be successful, upon which the Republicans would utilise this deadline as a secondary bargaining tool to reduce the healthcare costs of the state.

Outcome

There are two ways of thinking about this. Firstly, we have all been here before, with the fiscal cliff and sequester crunch talks at the end of 2012 providing a clear example that the US will likely call every event into the final hours. However, ultimately the parties will reach a half-hearted solution that will ‘kick the can down the road’ on the promise of a longer term resolution at another time. On the other hand, the experience of previous negotiations have turned members of the congress and the President into hardened and experienced negotiators in such circumstances. For this reason, some of the tones coming out of both the republicans within the House of Representatives along with the president are pointing to a more staunch and unwilling stance coming into the discussions.

The willingness of Obama to hold on to his pride and joy will certainly become increasingly tested over the coming weeks. Should this latest episode of game theory go to the wire, it is likely that the real costs would be borne out of the US economy and global markets. For many within the Congress, this is a matter of pride and one upmanship, yet as the prospect of insufficient budgets becomes a reality for management within the likes of the judicial system or healthcare industry, it is clear that some cuts will be made as a precaution. Whether they can be rectified so easily should the issue be resolved, remains to be seen.

The markets have a status quo is relation to crisis from within the US, and much of this has been seen over the past month. The inability of the US economy to function and operate properly is a global issue, and for this reason there are serious implications should it run down to the wire. Obvious safe havens come in the form of treasuries and safe haven currencies (JPY, CHF and to some extent the USD), while the likely sufferers would come in the form of risk assets such as non-defensive stocks and riskier or more exotic currencies.

Author: Joshua Mahony from Alpari.co.uk