The Treasury Secretary Jack Lew has made an impassioned plea to the Senate Finance Panel to raise the debt ceiling avert his department having to pick and choose what payments to make, or not make, this time next week. Lew’s calls for action to resolve this crisis have been growing in recent weeks, before reaching today’s crescendo. He gave an impressive performance; time will tell if he actually manages to influence the decision makers at Capitol Hill.
So far his description of the market panic that would ensue if the US does default has failed to rattle the markets. Stocks in Europe are still climbing and US futures are pointing to a higher open. Likewise, safe haven FX has been ditched in favour of riskier currencies. USD, EUR and GBP are the leaders in the G10 today, while the yen is weaker and USDJPY is testing 98.00, its highest level since last week. We are approaching some key levels in USDJPY – 98.30 – the 50-day sma and then 98.60 – 100-day sma, are key resistance levels. A move above these levels is a bullish development.
Do the cynics actually want the US to default?
So why are markets so serene in the face of this fiscal maelstrom? For the believers out there the prospect of a temporary increase in the debt limit is a sign of hope that the impasse can be broken (or, at least, kicked down the road). For the cynics, the calmness may be a sign of how markets have lost patience with the government and are fed up trying to react to every negative or positive sentiment coming out of Capitol Hill.
An alternative view on a US debt default is that it could be a good thing if it forces political change. Some have been calling for the Republican Party to split into two to try and dilute the effects of some of the extreme wings of the party who are being blamed for triggering this crisis. Perhaps this crisis has highlighted the need for a third dimension in US politics to stop these fiscal bottlenecks from becoming a regular event.
The death of the risk free asset
Back to the markets, the 1 month Treasury yield has been fairly stable so far today during Lew’s testimony, but after backing away from 0.33% highs, the dip so far has been shallow. The market is not willing to ease pressure on the short end of the Treasury curve and there are signs that it is starting to have repercussions. Earlier Hong Kong lifted its margin requirement for trading futures and using Treasuries with a maturity of 1-year or less as collateral. Thus, even with 1 week to go before the debt ceiling limit is reached Treasuries have already lost some of their credit-worthiness. Over the next few days expect other countries to follow suit; Japan’s markets association is in talks to prepare for a US default, and apparently it was a topic of discussion at today’s Bank of England meeting. Even if a last minute deal is reached, there is a chance that irreparable damage has been done to the US’s reputation and the concept of a “risk free” asset has been seriously challenged. The latter point could have a big impact on the future of investing.
US: losing respect as a custodian of the world’s reserve currency
Events outside of Washington may not be grabbing the headlines, but they remain significant. The ECB and China’s PBOC signed a EUR 45 billion currency swap today, which will make it easier for Europe to engage in trade and investment in China using renminbi rather than US dollars. This is a significant step to internationalising the use of the renminbi for trade and commerce (not for speculating, quite yet), and the announcement could not be more timely. The instability caused by the debt ceiling stand-off has led to some whispers over whether the US is politically responsible enough to be custodian of the world’s reserve currency. Jack Lew is being questioned on this point as I write, but surely some other world “super powers” see the political stand-off as an opportunity to boost the profile of their own currency? While the ECB/ PBOC news may not be tradable today, it could be a step towards further liberalisation of the renminbi for the future.
BOE: waiting for the minutes
The Bank of England meeting was a non-event, policy remained unchanged as expected and there was no accompanying statement. This adds extra emphasis to the minutes of this meeting, which will be released on 23rdOctober. We expect the BOE will want to keep any ammunition it has left in case the US does default in the coming days.
Could the dollar be the big winner from a default?
Overall, the US debt crisis is still dominating the markets’ consciousness if not its actions. Overall, tight ranges persist and there is a lack of direction in markets today. It still feels a bit like the calm before the storm to me. Although the short end of the Treasury curve is in panic mode, the long end is stable, which suggests to me that markets are concerned about liquidity and thus if there is a real default in the US then the dollar, perversely, could find itself in high demand.