Battle lines are drawn as US nears debt limit
The next big event risk for the forex market is the US budget debate. The question is whether the US will raise the debt ceiling which is expected to hit the 14.3 trillion mark by 16 May. A failure to raise the debt ceiling would prevent the US from paying interest on its current debt and restrict it from issuing new debt to fund the government. Last week S&P downgraded the US debt outlook to negative, heightening concern that the US could lose its AAA debt rating. In mid-April the US Congress passed a spending bill and avoided a government shutdown – but now the forex trade is bracing itself for the debate over the 2012 budget and whether the debt ceiling will be raised.
The battle lines in the US budget reform debate are being drawn. President Obama and the Democratic Party primarily focus on tax hikes to reduce the US deficit whereas Republicans are focused mainly on significant spending cuts including entitlements. Republicans say that there can be no deal if the Democratic Party seeks tax hikes. They are steadfast in their rejection of raising the debt ceiling without commitment by the government to spending cuts. The Obama administration has warned that failure to raise the debt ceiling could be catastrophic for the US economy. The polarisation of the US budget debate increases the risk that the debt limit may not be raised. Failure to do so could force the US into a technical default and would likely roil financial markets and send the US dollar (USD) sharply lower. The Swiss franc (CHF) traded at a record high versus the USD on Tuesday (26 April) partly on concern about the US debt outlook and the failure of the US to get its financial house in order.
Congress has never yet failed to raise the debt limit, raising the ceiling ten times in the last ten years. The current decision will probably depend on which US political party concludes they have the most to lose should budget reform fail to produce a compromise before the US debt limit runs out. Conventional wisdom is that some form of compromise will be made to avert a US debt crisis but this event risk is nonetheless on most forex traders’ radar screen.
