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Yet another effort to get “grand bargain” on the cutting the US deficit and raising the debt ceiling ended in break up. Each side is blaming the other, and the clock is ticking towards August 2nd. Or is it really ticking? Here are three ways this could unfold.

GOP leader John Boehner broke talks with US president Barack Obama late on Friday, after the markets closed. If this is the state of things when markets open on Monday, the dollar is set to decline. Washington is set to be very active over the weekend, and things can change afterwards as well.

  1. A deal is reached: Politicians like to negotiate until the eleventh hour, trying to squeeze every possible achievement before agreeing. The break up in talks could just be part of the game, with a deal reached before August 2nd. If an announcement on progress is made during the weekend, it will help markets.
  2. Another extension: Back in May, treasury secretary Geithner announced that the debt ceiling has been reached, and that creative accounting is used in order to buy time until August 2nd. This may be extended again: according to fresh calculations, upbeat tax revenue could in recent weeks can push back the “drop dead” date to August 9th or August 10th. This can give politicians more time to negotiate (and blame each other).
  3. Bringing the Fed: Ben Bernanke has control of the virtual printing presses. The US central bank could buy up government bonds that are about to mature. The US government will default on these bonds, as it reached the debt ceiling, and the Federal Reserve will see its balance sheet squeeze. Under the current policy of the Fed, with “QE2-Lite” the balance sheet needs to remain balanced, so the Fed will just buy some more.
When I wrote about the third option, it sounded like fiction. But as the clock ticks, the chances of this happening are growing. Geither already met Chairman Ben Bernanke and New York Fed President William Dudley to discuss what happens if the debt ceiling is reached.
All the options are on the table.
How do you think this will unfold?

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