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Deal Avoids The Worst But Delays Hard Decisions

BMI View: While a last-minute deal helped avert a first-ever US government default, we believe significant political hurdles to fiscal progress remain, and it is likely that noticeable damage has already been done to the US economy.

Sixteen days after the shutdown of the US federal government, and with the nation closing in on the October 17 debt limit threshold, Congress passed and President Barack Obama signed a bill that resolves the most recent fiscal crisis. The deal provides funding to re-open the government through January 15 and suspends the debt ceiling through February 7, and congressional leaders will use the intervening period to negotiate on fiscal policy, including whether to allow additional sequester spending cuts to go into effect early next year. While this resolution avoids a first-ever full-blown US sovereign default and allows hundreds of thousands of furloughed federal government workers to return to the ir job s , we believe the deal merely delays decision on long-term fiscal questions, rather than resolving them, meaning that the US is in store for more uncertainty and political risk in the months ahead.

Political Ramifications Could Be Significant

BMI View: While a last-minute deal helped avert a first-ever US government default, we believe significant political hurdles to fiscal progress remain, and it is likely that noticeable damage has already been done to the US economy.

Sixteen days after the shutdown of the US federal government, and with the nation closing in on the October 17 debt limit threshold, Congress passed and President Barack Obama signed a bill that resolves the most recent fiscal crisis. The deal provides funding to re-open the government through January 15 and suspends the debt ceiling through February 7, and congressional leaders will use the intervening period to negotiate on fiscal policy, including whether to allow additional sequester spending cuts to go into effect early next year. While this resolution avoids a first-ever full-blown US sovereign default and allows hundreds of thousands of furloughed federal government workers to return to the ir job s , we believe the deal merely delays decision on long-term fiscal questions, rather than resolving them, meaning that the US is in store for more uncertainty and political risk in the months ahead.

Political Ramifications Could Be Significant

We believe t he resolution of this crisis represents a clear defeat for the tactics employed by the more radical Republicans in the House of Representatives and the Senate . These legislators sought to tie government funding to the repeal of the president's landmark healthcare reform law (known colloquially as 'Obamacare') , but the final deal left the law untouched. Not only that, polling data indicate that the US public strongly object s to tying government funding to the healthcare law and blame s Republicans more than Democrats for the shutdown crisis ( see 'Shutdown To Worsen Tensions And Increase Gridlock', October 7 ) . Gallup reports that the Republican Party saw its approval ra ting fall to 28% in October, an all-time low.

We believe the repudiation of this more extreme wing of the party may, for a time, empower Republican moderates and increase the likelihood that we could see progress in the coming weeks on budget talks. However, while Republican lawmakers are likely to eschew the tactic of shutdown or debt-ceiling brinksmanship to win policy concessions, we caution that the distance between Democrats and Republicans on key policy issues, including taxes , spending, and the budget sequester currently in place, remains significant. As a result, there is a very real possibility that legislators will fail to reach common ground, meaning that another shutdown could occur in mid-January. Furthermore, the majority of House Republicans, who hold the lower chamber, voted against this deal, a rare occurrence that puts Speaker of the House John Boehner in a tenuous position. If he were to lose the support of his caucus, he could be replaced with a more hard-line negotiator, an outcome that would increase the potential for brinksmanship in the future.

Economy To Suffer

We believe that the two-week federal government shutdown, the first since 1996, will weigh noticeably on fourth quarter GDP numbers. Despite the fact that federal workers furloughed during the shutdown will receive back pay, the crisis caused a significant hit to consumer confidence that we believe will lead to less spending during the month of October ( see 'Confidence Drop On Shutdown Threatens GDP Growth', October 9 ). It is likely that business confidence numbers for the month will show a similar drop, meaning that investment and hiring could be delayed.

Additionally, the new timeline for budget talks, which runs through December and could see last-minute negotiating in January, increases the possibility that the US Federal Reserve will delay tapering its current asset purchasing programme (QE3) until well into 2014. While we believe the direct impact of the US$85bn monthly purchases is quite small, the psychological impact is significant, and the Fed may delay making any changes to current policy until there is greater certainty on the fiscal front. Additionally, economic data in the fourth quarter may convince the Fed to keep policy loose for the time being.

Market Impact Most Significant On Dollar

The impact of the shutdown and debt ceiling debate on US equity and fixed income markets before the deal was announced had been relatively small, and as such we do not expect a large rally now that the worst of the possible outcomes - a default on US debt - has been avoided. Moreover, the deal that was reached simply puts time back on the clock, and does not provide any clarity for how a longer-term deal will be reached. As such, we see little reason for markets to cheer the outcome.

That said, the resolution of the crisis has coincided with a sell-off in the US dollar ( see 'Dollar Still Looks Weak Vs EUR And GBP', October 17 ). If economic recoveries in the eurozone and the UK continue to take hold while the US remains under the cloud of continuing fiscal uncertainty, we could see an extended period of dollar weakness against the euro and sterling. Furthermore, if markets come to expect looser Fed policy for longer, then oversold emerging market currencies could see a period of multi-month strength against the dollar, too.

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Sector: Country Risk
Geography: United States
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