Debt Deal May Avert Default but Credit Ratings Downgrade Possible

Monday, 01 Aug 2011 07:02 AM

 

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An 11th-hour deal to resolve the U.S. debt crisis may avert the superpower's first-ever default and restore some confidence in the dollar, but it faces the risk of a costly credit downgrade, investors and economists said.

Japan welcomed news that late on Sunday, the White House and Republican and Democrat leaders agreed on a plan to raise the U.S. borrowing limit and avoid a catastrophic default, buoying the dollar and share markets.

Governments and policymakers had warned Washington of the risk of financial disaster if they failed to raise the $14.3 trillion U.S. debt ceiling. An official Chinese newspaper had called U.S. handling of the crisis "irresponsible" and "immoral."

The leaders' agreement still needs to be endorsed by Congress by Tuesday to allow the U.S. debt ceiling to be lifted in time to avoid default or a seizure of government finances.

"This looks like a short-term fix and we don't have a long-term solution put in place, which is really what the rating agencies were looking for," said Michael Woolfolk, senior currency strategist with BNY Mellon in New York.

Rating agencies had yet to react to the news.

The dollar rebounded against safe-haven currencies such as the yen and Swiss franc, and share markets rallied on news of the deal, which President Barack Obama said would lead to $2.5 trillion in cuts from the budget deficit over the next 10 years.

The price of gold, a safe-haven asset that had climbed to record highs on fears of stalemate on Capitol Hill, fell back on news of the deal, but analysts said credit agencies were likely to be less impressed than markets.

They noted the agreement called for just under $1 trillion in initial cuts, with a joint committee charged with finding another $1.5 trillion -- a task which, given the poisonous state of U.S. politics, seemed to promise yet more uncertainty.

"I am not sure this will be enough to remove the negative outlook," said Annette Beacher, head of Asia-Pacific research for TD Securities in Sydney. "I don't think it is necessarily a done deal that the ratings agencies will accept this program to avoid an eventual downgrade."

Markets are waiting for rating agencies to hand down their verdicts on the deal. Standard & Poor's had sent the clearest signal that it was prepared to downgrade the United States' top-notch AAA rating even in the event of a political compromise.

S&P signaled a possible U.S. downgrade last month, putting the rating on negative watch and warning that it might still cut the rating if a political deal lacked the resolve to stabilize the country's medium-term debt dynamics.

Japan, though, was relieved a political deal had been struck, with the safe-haven yen coming off its highs as funds swung back into the dollar.

But policymakers there were expected to remain on guard to defend the yen from another sharp appreciation, the last thing its disaster-struck economy needs.

"We welcome the U.S. debt deal and hopefully this will stabilize markets," Japanese Chief Cabinet Secretary Yukio Edano said at a regular news conference.

U.S. stock index futures bounced on news of the agreement, and the Japanese stock market surged as much as 2 percent, though U.S. Treasury futures fell slightly as the deal emerged.

Washington came under increasing international pressure at the weekend to come up with a solution.

IMF head Christine Lagarde told CNN that the world was watching the United States "with trepidation, with anxiety, with concern, but also with hope."

Asia, which holds close to $3 trillion in U.S. government debt, has a powerful vested interest in Washington finding a solution to avoid default.

China's People's Daily, the official mouthpiece of the Chinese Communist Party, on Saturday accused U.S. politicians of "sacrificing other people's interests in exchange for a few votes." China is the United States' biggest foreign creditor.

© 2014 Thomson/Reuters. All rights reserved.

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