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Three consequences of the US debt deal

PSI |  17 October 2013  | 

DealConsequencesThe bizarre goings on in the US government seem to have halted for the time being with an agreement to raise the debt ceiling. The AFR reports that it is set to go through both houses:

"Rank-and-file senators from both parties have agreed on a deal to reopen the government and extend its borrowing authority, Senate Democratic leader Harry Reid and Senate Republican leader Mitch McConnell have said.

"Under the agreement, the government would be financed at tight levels through January 15, reflecting across-the-board spending cuts that went into effect in March. The debt ceiling would be raised into February and negotiators would be required to complete work on a detailed budget plan for the next decade by December 13.

"The agreement would also end the 16-day-old government shutdown that has hit a number of US businesses reliant on government work. Wall Street surged on news of the deal, with the Dow closing 1.4 per cent higher and the S&P 500 climbing 1.4 per cent. The Australian dollar was higher at US95.51¢ and the SPI was up 20 points to 5272 by 7.30am AEDT."

The markets for the most part bet that this would happen, so it did not create much significant re-pricing that created oportunity for investors. But there are some probable implications from what has happened that may be of interest to SMSF owners.

1. The $A has risen sharply during this period. That means it can buy offshore assets cheaply. When, as is likely, the $A falls back to the levels it was at before this crisis -- the high $80c -- the value of offshore investments will rise.

2. It is likely that the Fed's pump priming will continue; the "taper", easing back from printing US dollars, is likely to be put off while the market stabilises. That means global interest rates will remain low, making Australia's interest rates relatively high compared with other developed economies.


3. Global stock markets are likely to stabilise, and the global economy will continue its stuttering recovery. That is probably good for Australian shares.

In terms of asset allocation, the choices have not changed greatly. Fixed interest securities are likely to underperform because of low interest rates, which makes cash yields poor. It also makes bonds unattractive globally, because when rates eventually do rise the value of bonds falls. And with rates so low, they are unlikely to drop much further. Australian rates are higher, but the RBA is making signs that it is unlikely to ease further.

Business Spectator expresses the conventional wisdom about the currency implications. The markets invariably bet against the conventional wisdom, so this must be taken with a grain of salt. Indeed, the prediction could very well prove wrong. Does it really matter that confidence in the $US has been harmed? What is the alternative? The Japanese yen? The Euro? Hardly:

"The end point of all of this is that the solution to the current impasse is temporary and the damage to the reputation of the US as a financial safe haven is severely damaged. The US dollar reserve currency status continues to erode as investors will increasingly shy away from the risks associated with holding US bonds. It is difficult to think that the central banks of China or Japan, for example, would be all that keen to add to their US Treasury holdings in the medium term. And in fact, with markets calm for now at least, they would be more inclined to run down their holdings.

"The US dollar seems a one-way bet – lower.

"For the US, with large and perpetual budget deficits for as far as the eye can see, this will create severe problems. Yields will have to rise to entice investors, but this will risk choking off growth and thereby mean more QE is needed and that the fiscal position will deteriorate."

One of the lessons in investment is that the obvious rarely transpires, especially in today's meta-markets, which are driven by computerised trading. Expect surprises.