After the debt binge, the mother of all hangovers - and it's not going to be pretty

Global equity markets behaved according to script yesterday and rocketed ahead when news broke that the US had moved closer to a debt deal.

Global equity markets behaved according to script yesterday and rocketed ahead when news broke that the US had moved closer to a debt deal.

But scratch the surface and the compromise reached shows that times will get tough as the Obama administration takes a knife to spending to get its budget deficit under control.

After the debt binge that the global economy has fed on, it is now time for austerity - deep austerity. It is sweeping through Europe, with Greece backing a ?78 billion ($101 billion) austerity plan as part of an agreement to receive a bailout, and Ireland, Portugal and Spain forced to take their own medicine. Now it is the US's turn.

As in Europe, the danger in the US is far from over. If the doomsayers are right and the US economy is on the brink of recession, then severe cuts will tip it into recession.

But it is a bullet the US has to bite, or face defaulting on debt repayments, which would have happened if it had not reached a compromise.

The news a deal had been reached pushed the Australian market 1.7 per cent higher. The Nikkei gained 1.3 per cent. Other markets are expected to play catch-up.

The Aussie dollar surged as well, as did crude oil prices, after investors endured a rollercoaster ride in recent days as they weighed the implications of a US default.

With those fears abated, gold prices, which hit record highs last week, slumped as investors tempered their demand for safe haven assets.

While the deal still has to be approved in both houses of Congress, and needs the backing of the Tea Party faction of the Republican movement, it looks like approval will be reached before tonight's deadline.

The proposed deal will raise the $US14.3 trillion ($13 trillion) debt ceiling by $US900 million, slash almost $US1 trillion from spending over the next decade and appoint a special committee to identify another $US1.5 trillion in deficit savings by the year's end.

Obama said the compromise would result in domestic spending falling to the lowest level - relative to the size of the economy - since the 1950s. It will be interesting to see what he does about taxes, which could become an issue after he earlier called for increases.

But it is worth remembering that the United States' AAA credit rating is still in danger. On July 14, the ratings agency Standard & Poor's warned there was a 50 per cent chance the rating could be cut even if an agreement was reached.

S&P will take up to 90 days to make its decision, and will weigh up whether the compromise deal includes "a credible solution to the rising US government debt burden".

Tough talk, but it is hard to imagine S&P cutting its rating as it would have profound implications across the globe, not just because it would be the first time in that the US rating would fall below the top notch, but because many pension funds have a mandate that only allows them to invest in AAA investments. The cost of borrowing would also likely increase, adding more strain to the budget.

- - -

THE well regarded Australian Securities and Investments Commission commissioner Shane Tregillis has pulled up stumps 15 months after rejoining the corporate watchdog after missing out on the top job.

Tregillis has taken up the role as chief ombudsman at the Financial Ombudsman Service (FOS), which resolves disputes between consumers and financial services providers such as banks, general insurance, financial planning stockbroking and managed funds.

FOS has had a reputation of being ineffectual, particularly when it comes to the fast and loose end of the industry, but the appointment of Tregillis, who has an intricate knowledge of the financial services market as well as market integrity rules, could be a sign that the ombudsman is ready to get serious.

Shadow brokers are proliferating. This is a potential problem as it is an area that is lightly regulated and has had a number of blow ups in recent years, including Sonray, Chartwell and Lift Capital.

And if speculation is right then another is about to hit the dust. Talk in broking circles yesterday was that a shadow broker, which BusinessDay knows the identity of, was on the brink of appointing voluntary administrators. It follows a series of problems in recent weeks including a creditor seeking to wind it up, ASIC suspending its Australian Financial Services Licence last month for a short time due to a breach, and the operator itself seeking to oust its auditor. The company didn't put any trades through yesterday, which could mean anything.

Join the Conversation...

There are comments posted so far.

If you'd like to join this conversation, please login or sign up here

Related Articles