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2 Oct 2013
Forget the “shutdown sunshower”, the real storm approaching is the US debt ceiling debate
FXstreet.com (Barcelona) - The US government shutdown is likely to be a non-event in the grand scheme of things, but the debt ceiling deadline – which is rapidly approaching – is likely to be a major market-moving catalyst.
President Obama will be forced to pick his Constitutional poison if the US debt ceiling is not raised
In a couple of weeks, President Obama will likely be forced (judging by the widening gulf between the political parties) to make a very difficult decision which is going to be a matter of choosing the least of three evils. The Constitution requires the President:
• To spend what Congress has instructed him to spend;
• To raise only those taxes Congress has authorized him to impose; and
• To borrow no more than Congress authorizes.
Raise your hand if you would like to be in the President’s shoes right now! He is going to have to break the law soon by violating one of those three mandates – it’s just a matter of which one. Talk about picking your poison!
Poison Flavor 1: Don’t pay the country’s bills
Under this scenario, we would have employees not getting paid, social security checks cut, veterans’ benefits slashed andinterest payments cut if not eliminated. This option will likely lead to the country’s debt being rated down and interest rates being elevated – which would be catastrophic for our country and the financial markets.
Poison Flavor 2: Raise taxes unilaterally to compensate for the higher expense levels
This is an option, but not a likely one. If Obama raised taxes unilaterally, it may help cash flows temporarily, but it also would be another obstacle for the already delicate economic recovery – possibly reversing those cash flows down the road.
Poison Flavor 3: Surpass the country’s debt ceiling so the bills can be paid and taxes not raised
Under this scenario, the bills get paid and taxes stay where they are – but Obama would be attacked by his political enemies and maybe even impeached by the House of Representatives – although the Senate would never vote to go through with an impeachment.
Are the markets clearly forecasting anything right now?
In any of the above cases, the financial markets are going to react negatively in all likelihood. Look for yields to drop leading up to the debt ceiling deadline as the markets and the FOMC do their best to prepare for any sudden upward pressure from the US’s ratings being lowered. The lower yields should correspond with a lower DXY.
If scenario 1 above plays out, yields will rise on any credit downgrade, but from what base? If the FOMC does their prep work, any rise should be off a very low starting point for yields. It is hard to imagine the DXY catching a bid, though, even if rates get pumped up.
If scenario 2 plays out, rates will probably still rise – but perhaps not as much. Again, the DXY will likely move directionally right along with interest rates.
If on the other hand, scenario 3 plays out with Obama joining the fray and trying to assume the role of heroic problem solver, rates and the DXY will probably rise as a result – but less so than under either of the first two scenarios.
No matter how the political action plays out, expect more volatility in the markets in the short-term. Right now, it appears likely that both yields and the DXY have more room to fall before the macro downside targets (DXY 79.55 and the 10-year Treasury at 2.465%) for the current down move are hit.
President Obama will be forced to pick his Constitutional poison if the US debt ceiling is not raised
In a couple of weeks, President Obama will likely be forced (judging by the widening gulf between the political parties) to make a very difficult decision which is going to be a matter of choosing the least of three evils. The Constitution requires the President:
• To spend what Congress has instructed him to spend;
• To raise only those taxes Congress has authorized him to impose; and
• To borrow no more than Congress authorizes.
Raise your hand if you would like to be in the President’s shoes right now! He is going to have to break the law soon by violating one of those three mandates – it’s just a matter of which one. Talk about picking your poison!
Poison Flavor 1: Don’t pay the country’s bills
Under this scenario, we would have employees not getting paid, social security checks cut, veterans’ benefits slashed andinterest payments cut if not eliminated. This option will likely lead to the country’s debt being rated down and interest rates being elevated – which would be catastrophic for our country and the financial markets.
Poison Flavor 2: Raise taxes unilaterally to compensate for the higher expense levels
This is an option, but not a likely one. If Obama raised taxes unilaterally, it may help cash flows temporarily, but it also would be another obstacle for the already delicate economic recovery – possibly reversing those cash flows down the road.
Poison Flavor 3: Surpass the country’s debt ceiling so the bills can be paid and taxes not raised
Under this scenario, the bills get paid and taxes stay where they are – but Obama would be attacked by his political enemies and maybe even impeached by the House of Representatives – although the Senate would never vote to go through with an impeachment.
Are the markets clearly forecasting anything right now?
In any of the above cases, the financial markets are going to react negatively in all likelihood. Look for yields to drop leading up to the debt ceiling deadline as the markets and the FOMC do their best to prepare for any sudden upward pressure from the US’s ratings being lowered. The lower yields should correspond with a lower DXY.
If scenario 1 above plays out, yields will rise on any credit downgrade, but from what base? If the FOMC does their prep work, any rise should be off a very low starting point for yields. It is hard to imagine the DXY catching a bid, though, even if rates get pumped up.
If scenario 2 plays out, rates will probably still rise – but perhaps not as much. Again, the DXY will likely move directionally right along with interest rates.
If on the other hand, scenario 3 plays out with Obama joining the fray and trying to assume the role of heroic problem solver, rates and the DXY will probably rise as a result – but less so than under either of the first two scenarios.
No matter how the political action plays out, expect more volatility in the markets in the short-term. Right now, it appears likely that both yields and the DXY have more room to fall before the macro downside targets (DXY 79.55 and the 10-year Treasury at 2.465%) for the current down move are hit.