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US Economy, Public Finances Not Out Of Trouble Despite Votes - Strategists

Tom Burroughes, Group Editor , London, 3 August 2011

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This article was written a few hours before the Senate voted in favour of the fiscal package as passed the previous day by the House of Representatives. 

The furore over the US debt “ceiling” argument in the US, which produced a last-minute vote in Congress to break a deadlock, will not allay fears about a vulnerable US economy or the ability of policymakers to deliver on big deficit cuts, investment strategists say.

On Monday night, the Republican-controlled House of Representatives passed a deal to cut a widening deficit and lift the $14.3 trillion debt ceiling by a sufficient level to continue past the November 2012 elections. The US Senate, as expected, approved the deal yesterday. It is due to be signed into law by President Barack Obama.

The debate had pitted Democrats against Republicans who, in the latter case, had regained power in the House with support of the Tea Party movement, which has lobbied for large cuts in spending and taxes in the wake of the TARP bank bailouts and fiscal stimulus packages of recent years.

Media reports said the debt ceiling wrangle, which was resolved - if only politically - barely hours before the US defaulted on its debt obligations, had hurt the reputation of the world’s largest economy and sown more doubts about whether the country can hold its AAA credit rating.

Investment managers gave a mixed reaction to the Congressional outcome.

“The debt-ceiling debate has been an engrossing watch but one thing we can be sure about - there is absolutely no chance of the US defaulting on its obligation. The Treasury's debt service cost is considerably lower that its overall receipts,” according to Manish Singh, head of investment services at Crossbridge Capital, a London-based wealth management boutique.

“As it is a deal borne out of compromise on both sides, maybe that's not such a good thing after all. A near-term cut could do enough to endanger a weak recovery and not enough in over-all cuts would leave hanging the spectre of ratings downgrade,” Singh said.

He said that if the US continues on its current fiscal path, the CBO (Congressional Budget Office) projects a sharp rise in the US debt to GDP ratio from 69 per cent to 100 per cent by the end of 2021. A deficit cut of $6 trillion is needed to restore that ratio to a more manageable 60 per cent, he said.

Singh said that “Bush era tax cuts” and the recession has meant that at 14.4 per cent of GDP, the tax revenue has been the lowest since 1950. Revenue has averaged 17-18 per cent of GDP between the 1970s to early 2000.

“A deficit reduction plan that doesn't take into account contribution from revenue is unlikely to be implemented successfully and wholly,” he said.

From an asset allocation point of view, Singh said that a higher debt ceiling means more money printing by the Fed – which will boost gold prices further from its existing record level.

GDP concerns

Bob Doll, chief equity strategist for fundamental equities at BlackRock, the giant US fund manager, warned that the “circus” over the debt ceiling had taken attention from poor recent US gross domestic product figures. On Friday, second-quarter GDP was revised sharply downward to 0.4 per cent from an original figure of 1.9 per cent – a huge change.

“From an economic perspective, the US economy remains vulnerable, which is not a comfortable backdrop for risk assets, but we continue to believe that the probability of recession remains low and that economic data should improve in the coming months. To us, all of this suggests that the positive forces for the markets should win out, but for that to happen additional clarity is key,” Doll said.

“Even with the immediate risk of the debt ceiling issue likely fading for now, however, there remains a risk that one or more of the credit ratings agencies could downgrade the credit rating of the US. It is unclear whether any agreement on long-term debt issues will reverse the trend of debt growing faster than GDP — an issue on which the ratings agencies remain highly focused,” he said.

Rupert Watson, head of asset allocation, Skandia Investment Group, said the reputation of the US had suffered from the affair.

"Although Congress was finally able to reach agreement, confidence in the ability of the US to solve its problems has been damaged. The US system of government requires the different parties to be able to compromise to reach agreement. However, some of the current incumbents seem willing to risk all to make an ideological point. With the US economy already weak and with problems in the peripheral European economies intensifying, the willingness of some to push the US to the edge of disaster could not have come at a worse time," he said.

 

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