Why the Real Doomsday Isn't October 17
There’s a misconception out there that the US will automatically run out of cash on October 17 and immediately default on its debt, and while that’s not entirely true, the risks are growing more dire by the hour.
For the past two weeks, investors have been hopeful that Congress would pass a bill to re-open the government and avoid the first ever US debt default, but now 15 days into the shutdown and with less than 36 hours to go before the Treasury reaches its borrowing limit, the optimism is fading fast.
Stocks resumed their slide today, carry trades were liquidated, and the US dollar (USD) extended its losses against most major currencies after the White House rejected the House proposal and talks in the Senate broke down.
To date, currencies and equities are seeing a controlled selloff, even after rating agency Fitch put the US credit rating on negative watch, although many investors fear that the dollar will collapse if the US defaults on its debt.
Thankfully, October 17 is a soft, and not a hard deadline. While we would certainly like to see a deal reached before this Thursday, at this stage, it is growing increasingly unlikely. Last month, US Treasury Secretary Jack Lew said "We estimate that on October 17, the Treasury would have only approximately $30 billion to meet our country's commitments. This amount is far short of net expenditures on certain days, which can be as high as $60 billion.”
The key words there are "certain days." The US government won't automatically miss its first bond payment exactly on October 17, but it could happen shortly thereafter. To buy some more time, the government could prioritize certain payments, but this strategy is not sustainable, especially since there is a major benefits payment due on November 1, which is the day many consider to be the real doomsday.
While we expect the dollar to extend lower if the October 17 deadline passes without some kind of deal being struck, we don't expect the greenback to instantly drop another 5% or 10%. If Congress manages to pass a bill to raise the debt ceiling and re-open the government by Monday, it would still be enough time to avoid a default.
Read Special Report: Lesser-Known Facts About Trading the Debt Crisis
Japan Kicks off 53-Day “Diet Session”
The breakdown in the US budget talks drove the Japanese yen (JPY) sharply higher against all major currencies on Tuesday, and if there is no deal by tomorrow, we could see another 1% slide in the JPY crosses. USDJPY, in particular, could erase all of its recent gains and drop below 97.
Over the next 24 hours, the market's risk appetite will continue to be the primary driver of currency flows. The yen will fall if Congress magically produces an eleventh-hour deal, but if it fails, we expect the yen to move lower as more investors liquidate out of JPY crosses.
However, the US isn’t the only country whose politics are worth watching. Last night, Japanese Prime Minister Shinzo Abe kicked off the government's extraordinary 53-day “diet session.” During this session, policymakers will finalize the details of the 5-trillion-yen stimulus package, which is being called the “Third Arrow of Abenomics.”
This will entail important discussions regarding a reduction in the corporate tax rate and various tariffs, and while flushing out Abenomics won't be easy, the heightened encouragement of foreign direct investment is clear.
The Japanese government hopes to establish special economic zones with less regulation in hopes of boosting business investment. The 53-day session runs until December 6, after which lawmakers are expected to announce the details of their plans. That’s quite a long time, though, especially considering the imminent risk of the US breaching its debt limit, so for that reason, Japanese fundamentals have taken a backseat to the troubles in the US.
By Kathy Lien of BK Asset Management
DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.