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Financial armageddon will probably be avoided in the U.S.. But, that won’t necessarily be good news for the dollar.
On the contrary, protracted negotiations on raising the U.S. debt ceiling could well increase the threat of a ratings downgrade, and at the same time talk of further U.S. monetary easing is likely to return.
In other words, neither fiscal nor monetary forces will be working in the dollar’s favor for the foreseeable future.
Hopes had been high before last weekend that President Obama was close to hammering out a deal with the Republicans on raising the debt ceiling and allowing the Treasury to continue raising money.
But, with the talks now in tatters and the August 2 default deadline drawing closer, it looks increasingly likely the two sides will only come up with a short-term compromise that will keep the Treasury solvent but postpone any tough decision on spending cuts and tax increases until next year.
The problem then, of course, is that negotiations could prove even more difficult as they will be taking place just as the two parties start their campaigns for the next presidential election.
This will hardly put the U.S. in a good light and with credit agencies likely to keep their threat of a U.S. downgrade alive, Washington could well find it has to offer a weaker dollar and higher Treasury yields to keep foreigners buying its debt.
So, the fiscal stresses that have overshadowed the dollar for the last few months could actually intensify if Congress fails to find a longer-term debt solution.
And, the pressure from monetary policy isn’t going to be much better.
Although the U.S. Federal Reserve made it clear only a few weeks ago that it doesn’t have any plans for easing monetary policy any further, calls for more quantitative easing are likely to increase again in coming weeks as the pace of the U.S. economic recovery continuous to disappoint.
This week will likely bring more evidence of just how badly the recovery has stumbled with house prices expected to continue falling and with the recent weak payroll figures likely knocking consumer confidence levels even lower. Growth in durable goods orders is expected to have slowed and, most importantly, GDP data on Friday will not only show that annualized second quarter slowed to 1.8% from 1.9% in the first quarter, but that previous growth estimates for the last year or two were revised down.
Although the dollar may be weathering the latest headlines on the debt negotiations out of Washington rather well, with the Dollar Index actually staging a small rally, chances are the U.S. currency could be heading for a nasty fall, especially if more disappointment on the debt ceiling coincides with another batch of negative economic numbers that puts QE3 back in the frame.
Despite last weekend’s breakdown in congressional debt ceiling negotiations, financial armageddon will probably be avoided as U.S. legislators will eventually move back from the brink of default.
But, this may not be such good news for the dollar.
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The debt ceiling is an anachronism and should be eliminated. As usual, it’s an empty exercise in political posturing, allowing politicians to take the high ground of fiscal prudence while they cheat in actual spending legislation. The very nature of the debt ceiling is illogical and self-contradictory such that it nullifies itself. Would any Congress pass a law that acted as a self-destruct button for the US Government and the American economy? Would any law that did act as a self-destruct button have any legitimacy outside of a Constitutional Amendment? The debt ceiling is nothing better than a pantomime. All show, no substance.
The Source is WSJ.com Europe’s home for rapid-fire analysis of the day’s big business and finance stories. It is edited by Lauren Mills, based in London.
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