Countdown to U.S. Default: An Update

With only a couple of hours left before Treasury Secretary Jack Lew’s October 17 deadline, let’s take a peek at what’s been happening with the debt ceiling debates and how it has affected the dollar

What’s been happening?

1. Talks between Obama and the Republicans yielded no deals.
A few days ago Obama met with Republican leaders to discuss a possible deal, which would have extended the Treasury’s authority to borrow money until November 22 in exchange for Obama’s commitment to a long-term deficit reduction plan. Obama has neither rejected nor approved of the plan and no deal has been reached.

2. The Republicans scrapped a plan that the Senate would have rejected anyway.
Yesterday Republicans leaders presented a plan to the House that would have reopened the government until January 15 and extended the Treasury’s borrowing authority until February 7. The proposal encountered opposition from the ultra conservatives, who said that it didn’t have enough bite to curb ObamaCare. Word around the hood is that the Senate would have rejected it anyway.

3. Fitch put the U.S. credit rating on downgrade watch.
Fitch placed the U.S. AAA credit rating on the chopping block after the House failed to pass a bill to the Senate yesterday. The credit ratings agency stated that the failure to raise the debt ceiling dents confidence on the government, political institutions, and the credibility of economic policy.

4. The pressure to compromise builds up.
China and Japan, the world’s second and third largest economies, have stepped up the pressure to reach a solution to the debt ceiling debacle. Zhu Guangyao, China’s Vice Finance Minister, said that “the clock is ticking” and urged U.S. policymakers to “ensure the safety of the Chinese investments.” Over in Japan, Finance Minister Taro Aso called on the U.S. to “resolve its stand-off without delay.” Talk about pressure!

Why aren’t investors more worried?!

Surprisingly, the dollar’s price action has been pretty muted for the past couple of days. One possible reason is that a miss in the October 17 deadline is already priced in.

Another possible reason is that investors are still expecting a last-minute deal. Analysts estimate that the Treasury would still have around $30 billion in cash by October 17, which could be used to pay obligations for about another week. Non-conventional methods, such as Obama declaring a state of emergency and scrapping the debt ceiling as well as the Treasury selling its assets have also made it to the market grapevines.

The real pinch would be felt in October 22 (when $12 billion will be allotted to social security payments), October 31 (when $6 billion worth of interest payments on debt is due) and November 1 (when $55 billion worth of bills will need to be covered).

For now it looks like investors around the world are watching developments closely and are mostly taking the lack of progress in stride. However, as we step closer to the time when the U.S. government runs out of money, we might see dollar weakness and even risk aversion. Keep this in mind if you’re planning on keeping open trades over the next couple of days!