US debt deal is finally sealed It’s over! Late Sunday night (US time) President Obama announced that US Congressional leaders had reached agreement on a deal involving $2.5 trillion of spending cuts ($1 trillion over the next decade and the rest at some unspecified time in the future) in return for a rise in the debt ceiling of $2.4 trillion.
This will avoid the President having to ask Congress for a further rise ahead of the Elections in 2012. The markets are happy; the ASX 200 is up 1.7% and the USD$ is stronger by about the same. It looks on the surface like a classic compromise deal. Whilst no-one will be thrilled with the outcome, there does appear to be something for everyone. Republicans are delighted that ‘job-killing tax hikes’ have been excluded, Democrats are happy with the vagueness of the spending cuts, and President Obama will be mightily relieved that he does not have to go through this process again before the next election.
However, will this be enough to stave off a cut to the AAA credit rating of US Treasury bonds? We think not, and expect S&P to downgrade the US to a rating of AA within a month. Yet this is not the catastrophic event that many excitable journalists are predicting, and we see little short term impact on the healthy functioning of the US bond market.
See http://www.usdebtclock.org/ for the latest US debt numbers in real time.
Attention will now inevitably return to the rapidly stalling US economy. Little noticed amongst Friday’s frenzied debt negotiations was the release of a truly dreadful second quarter US GDP report, which showed growth in the world’s largest economy had slowed to an annualized rate of just 1%. This was worse than even the most bearish forecasts. In addition, the report showed that the 2008/09 recession was actually deeper than previously thought. Growth of 2.5% is required just to stop the unemployment rate (currently 9.1%) from rising. QE3 may be coming to a cinema near you…
Will the RBA raise rates tomorrow?
Only a fortnight ago, Westpac’s Chief Economist, Bill Evans, went out on a limb and predicted that the RBA would cut rates by 100bp over the next 12 months. Tomorrow the RBA meets to decide whether to raise rates by 25bp to 5%. Talk of rate hikes may seem crazy to many, given the obviously weak state of the Queensland and NSW economies.
However, the RBA (unlike the Fed which has to keep an eye out for the health of the economy) has only one mandate – to keep inflation between 2% and 3%. And last week’s report showing headline inflation creeping up to 3.6%, was a little too high for comfort. The consensus is for no rate hike and we are happy in this case to agree with the majority. However it will be a close call. A bunch of bananas will soon cost as much as a pair of women’s shoes. And one client recently pointed out to me that in Woolworths a toaster is now cheaper than a loaf of bread.
