Democrats, Republicans and the White House seem to have made progress, which should ease concerns about default and raise the long term value of the USD. The (yet not fully specified) agreement seems to have the following features:
1) The debt ceiling will be extended by USD2.4/2.5trn, in 2 installments. Now, it will be extended by USD1.2trn and later, the rest. KEY for the White House: the extension of the US debt ceiling will be automatic if no congressional agreement is made, and hence Obama will NOT be subject to another situation like this during THIS administration. The debt ceiling won’t be the arm-twisting device for the team party any more.
2) Spending cuts for USD2.5/2.8 trn over the next 10 years (near 1.9% of GDP of primary fiscal adjustment) have been agreed. USD1trn in spending has already been agreed. A bipartisan US senate commission will propose the remaining USD1.5/1.8trn and the congress will have to vote for yes or now before yearend. IF congress turns the commission proposal down (and they run out of time again after fine-tuned versions are proposed), automatic triggers cut spending in social entitlements down with NO hikes in taxes to meet the committed savings of USD1.5/1.8trn (this makes the proposal for savings credible, independently of how saving targets are met, through spending of taxes).
3) The proposal contemplates NO increases on the revenue side. This should support job creation going forward, in spite of the front loaded cuts in spending (that are likely to be a headwind for the US economy in the coming months).
I think this outcome is better than what the market was expecting by the end of last week. It should be supportive of US and global growth (in spite that one should still not be overly-excited about the US economy), by doing all the savings through spending rather than tax hikes. Still, this is not the best fiscal plan because it is somewhat frontloaded in savings, and the best plan should have no spending cuts for the coming months to support the anemic growth and get the economy moving (it should rather cut entitlements down the road).
The probability of a US credit rating downgrade would likely be revised down by our clients (I would say over 80pc of them where looking for a downgrade as of last Friday), and I would say now it is closer to 50% (from above). This is Dean Maki’s call and we’ll likely hear from him tomorrow. Still, I would think a downgrade is the most likely outcome because the fiscal plan does not pull the US economy out of the woods, and the congress remains dysfunctional. I would say we are still USD1trn short in savings for S&P to be happy with this. The inability to increase taxes must be still a problem for S&P. The US creditworthiness remains vulnerable to downturns, something a AAA credit should be able to withstand. But it is certainly a tougher call now.
Overall, positive for the USD, negative for safe heaven currencies, negative for UST (I expect wider rates on a relief, as the market was likely expecting a worse outcome, lower US growth and so forth). Also this should be positive for US equities, as the plan should be better than expected for US growth.
BARCLAYS CAPITAL
ECONOMICS RESEARCH