Times will get incredibly tough as the Obama administration takes an extra sharp knife to cut spending to get its budget deficit under control.
GLOBAL equity markets behaved according to script yesterday and rocketed ahead when news broke that the US had broken the political impasse and moved closer to a debt deal.
But scratch the surface and the compromise reached shows that times will get incredibly tough as the Obama administration takes an extra sharp knife to cut 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 ($A102 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.
However, like Europe, the danger signs in the US are 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.
Nevertheless, it is a bullet the Obama administration has to bite, or face rushing headlong into defaulting on debt repayments, which would have happened if it had not reached a compromise with the Republicans.
The news buffeted the ASX 1.7 per cent higher and Japan's Nikkei 225 1.3 per cent higher. Other markets are expected to play catch-up. A tentative deal was struck yesterday and has resulted in the Australian and Japanese equities moving sharply higher. The Aussie dollar surged as well, as did crude oil prices after investors endured a rollercoaster ride in recent days as they weighed real fears of the global implications of a US debt default. With fears of a default abated, gold prices, which hit record highs last week, slumped as investors tempered their demand for safe-haven assets.
While the all-important deal still has to be approved in both houses of Congress, and needs the backing of the ultra-conservative Tea Party faction of the Republican movement, it looks like approval will be reached ahead of tonight's deadline.
The proposed deal would 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.
President Barack Obama said the proposed 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 US's all-important AAA credit rating is still in danger. On July 14 credit ratings agency Standard & Poor's warned that there was a 50 per cent chance the AAA rating of the US could be cut even if an agreement was reached.
S&P will take up to 90 days to make this 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 the country's history that its 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.
A coalition of investment advisers and asset managers, including BlackRock, joined forces last week to publish an open letter to President Obama and all members of Congress calling on the nation's leaders to ''fix the deficit for real''.
BlackRock, which manages $US3.6 trillion in assets, put out a statement yesterday applauding the compromise but warned that the precise composition and timing of any spending cuts would determine whether the proposal produces a real and significant reduction in the deficit.
THE well regarded Australian Securities and Investments Commission (ASIC) commissioner Shane Tregillis has pulled up stumps 15 months after rejoining the corporate watchdog after missing out on the top job to Greg Medcraft.
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 pretty ineffectual, particularly when it comes to the fast and loose end of the industry, but with the appointment of Tregillis, who has an intricate knowledge of the financial services market as well as market integrity rules, it could be a sign that FOS is ready to step up to the plate and get serious.
It comes at a time when 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 AFSL 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.
Frequently Asked Questions about this Article…
How did the US debt-ceiling compromise affect global markets and Australian investors?
The tentative debt-ceiling compromise eased fears of a US default and sparked a sharp market rally: the ASX jumped about 1.7% and Japan’s Nikkei 225 rose about 1.3%. The Aussie dollar and crude oil prices also surged, while gold—having hit record highs the week before—slumped as investors reduced demand for safe-haven assets.
What are the key elements of the proposed US debt deal everyday investors should know?
According to the article, the proposed deal would raise the $US14.3 trillion debt ceiling by $US900 million, slash almost $US1 trillion from spending over the next decade, and appoint a special committee to identify another $US1.5 trillion in deficit savings by year’s end. The plan still needs approval in both houses of Congress and support from the Tea Party faction.
Could the planned spending cuts push the US economy into recession, and what does that mean for my investments?
The article warns that deep austerity could tip the US into recession if the economy is already fragile. For investors, that means potential volatility: spending cuts might lower growth and corporate profits, while failure to reach a deal would have caused even more severe market disruption. The compromise was framed as necessary to avoid a default, but the timing and composition of cuts will matter for markets.
Is the US AAA credit rating still at risk and why should investors care?
Yes. Standard & Poor’s warned there was a roughly 50% chance the US AAA rating could be cut even if a deal is reached. S&P said it will take up to 90 days to decide and will look for a “credible solution” to the rising debt burden. A downgrade could raise borrowing costs and affect pension funds and portfolios that require AAA investments.
What did BlackRock say about the debt compromise and why is that relevant to ordinary investors?
BlackRock—part of a coalition of advisers that urged lawmakers to fix the deficit—applauded the compromise but cautioned that the exact makeup and timing of spending cuts will determine whether the proposal produces a meaningful deficit reduction. BlackRock’s viewpoint matters because it manages large amounts of assets ($US3.6 trillion) and represents institutional investor concerns about long-term fiscal credibility.
How did safe-haven assets like gold respond to the news, and what should investors take from that?
Gold prices slumped after the deal eased default fears; the metal had hit record highs the previous week when fears were highest. For investors, this highlights how safe-haven assets can move quickly on political and fiscal news—rallying when default risk rises and retreating when that risk appears contained.
What change at the Financial Ombudsman Service (FOS) was reported and why does it matter to Australian investors?
ASIC commissioner Shane Tregillis left after 15 months to become chief ombudsman at the Financial Ombudsman Service, which handles disputes between consumers and financial services providers (banks, insurers, planners, stockbrokers, managed funds). His appointment—given his market integrity experience—could signal a stronger, more effective FOS for consumer protection.
What are ‘shadow brokers’ in the broking industry and what risk do they pose to investors?
The article describes ‘shadow brokers’ as lightly regulated broking operators that have produced several recent blow-ups (examples named include Sonray, Chartwell and Lift Capital). One shadow broker was reported to be on the brink of appointing voluntary administrators after creditor pressure and an ASIC AFSL suspension. For investors, shadow brokers can pose counterparty and operational risks, so awareness and due diligence are important.
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