Fed printing presses unaffected by shutdown!

By Filipe R. Costa

While the battle between Obama and the Republicans over the Federal Budget rages, investors around the world appear remarkably sanguine. After all, they’ve become well used to the “all-in” political bluffs of this game, which always result in last minute “folds”. Unlike in 2011, when the deficit ceiling debacle led to a collapse in stock prices and a massive leap in volatility, this time prices have barely budged. Even with the government partially closed, business for the rest of the world continues as normal.

Although the shutdown is hardly healthy, the main risk for investors remains a failure to resolve the latest debt ceiling row. The only “solution” appears to be raising the borrowing limit once more. If Congress and the White House fail to agree on this, the Federal Government will be unable to service its debts, within the next few weeks.

The implications of such an event are profound in the extreme. It would almost certainly signal the beginning of the end of the dollar as the world’s reserve currency. Faith in it as a trustworthy medium of exchange will be shattered. Interest rates would rise substantially, undermining growth and the ability of the US government to raise further debt. America would be forced into an extreme austerity drive, which would likely mean the end of Obamacare and all those military expenses!

For the time being though, it is clear no one really believes this scenario is going to happen. The yield on the 10-year treasuries is still at 2.62%. It is true that the yields on 1-month Notes rose from 0.035% to 0.12% during the last week, but for the most part everything else remains stable.  

If ever we needed evidence of the crazy times we live in, it is madness that the US Government is on the verge of breaching its self-imposed debt limit, yet again, and this isn’t perceived as increasing risk. It is madness that large parts of the federal government are shut and this isn’t perceived as increasing risk. It is madness that the shutdown looks like it will reduce quarterly GDP growth by 0.3%, at least according to Standard & Poors, and this isn’t perceived as increasing risk.

While talking about Standard & Poors, let’s also remember that this was the same agency that cut the US’s debt rating in 2011 in response to that summer’s brinkmanship. Their silence now is deafening. Rather than warn the world of the consequences of an American default, they are instead saying the current problems are unlikely to change their rating of US debt. Given that the current management of this agency have been so keen to point the finger of blame at the previous regime, this is hardly surprising.

As for the wider lack of concern as the debt clock ticks down, perhaps this can be explained by the actions of the Federal Reserve. The Fed’s printers haven’t been affected by the shutdown and this month’s $85billion of asset purchases have already been announced. Of course, all this artificial liquidity keeps a lid on borrowing costs. Apparently it doesn’t matter that this distortion of the market encourages and sustains poor leadership. With America so desperately in need of significant structural reform, this can never happen while the Fed keeps the credit line going.

But living off tomorrow cannot last forever.