US Debt negotiations – 17th October deadline and what it could have siginifcant impacts on the UK's fragile recovery.
The Republicans and Democrats continue to play chicken with each other over a budget agreement for the US government. Unless someone blinks before the 17th October, the United States could be forced to default on some of its foreign debt interest payments. The old investment saying goes ‘If America sneezes, the rest of the world catches a cold’ with that in mind, Hargreaves Lansdown’s Head of Research Mark Dampier gives his thoughts on what it could mean for UK investors. What happens if the US government can’t resolve its budget crisis by midnight of 17th October? It would mean that what is considered the world’s most important and safe asset, US treasury bonds, would not be able to pay interest on their debt so the risk of a Lehman type moment is possible. But the Americans don’t live in isolation. As the world’s most important and biggest economy there has to be a huge knock-on effect around the world.
A default on US treasury debt would see the dollar go down against leading currencies. I would expect equities to fall but by how much I don’t think anyone has a clear idea. Sovereign debt i.e. UK government Gilts and German Bunds would probably follow the US treasury market. A possible default would see the price of the bonds fall in value and yields rise although so far the threat of this has not seemingly caused a major problem to bonds. It is also important to acknowledge that we’re really not sure how this will play out. For example if US Treasuries do come under pressure then investors could pile into Bunds and Gilts simply in pursuit of ‘the next safest thing’.
I would expect physical gold to rise as it remains the final store of value in a crisis. Other than that the most uncorrelated asset to all this would be cash.
So Should you sell everything and sit in cash? A great question and if we could be sure of the outcome of October 17th we could be sure of an answer. Because this is such a momentous decision the market has remained fairly sanguine. In reality no one believes this will actually happen. The market is betting on a last minute deal at five to midnight so at the moment I am sure the volume of shares being traded, particularly in the States, is tiny as I believe the market is expecting a rally once the deal is done. Conversely of course if no deal is done I think the market fallout could be far more severe.
If I am retiring in three months should I sell now to avoid a market collapse? What about in five years? What about gilt yields, will we see annuity rates fall? I refer to the answer to the last question. I would stay invested as I still think a solution will be found but if you want to eliminate any risk of market volatility in the short term, then the logical thing to do is to sell now. Those with a five year view should just put on their tin hat. If US treasuries fall in value then I would expect gilt prices to follow them. This could mean annuity rates rise, though of course with annuities there are many other factors involved.
What about mortgage rates? For the same reason we could see a rise in fixed rates for mortgages. If they don’t fix the problem on the 17th can they just sort it out on the 18th instead without anyone really worrying about it or will trust in the US government and dollar be permanently damaged? Everything can be sorted out but the damage done to the politicians and the American government will be quite severe I think. From a political stance President Obama has little to worry about as he won’t be standing in the next election. The damage will be done to the Republican Party who will be seen to be trying to block the Obama healthcare plans despite the fact they have been passed by the United States government.
