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.
aferguson@fairfaxmedia.com.au
Frequently Asked Questions about this Article…
What was the US debt compromise and how did global markets react?
The article says a tentative US debt compromise would raise the roughly $US14.3 trillion debt ceiling by $US900 million, cut almost $US1 trillion from spending over the next decade and set up a special committee to find another $US1.5 trillion in savings. Markets reacted positively: the ASX jumped about 1.7%, Japan’s Nikkei 225 rose ~1.3%, the Australian dollar surged, crude oil prices went up and gold — a safe‑haven asset — slumped as fears of a US default eased.
How could planned austerity and spending cuts affect the US economy and everyday investors?
The article warns the Obama administration’s planned sharp spending cuts amount to deep austerity. If the US economy is already fragile, severe fiscal tightening could tip it into recession. For investors that can mean weaker corporate earnings, higher market volatility and sector‑specific impacts — exactly why the timing and composition of cuts matter for market outcomes.
Is the US credit rating still at risk after the debt deal?
Yes. Standard & Poor’s told the market there remained about a 50% chance the US AAA rating could be cut even if an agreement is reached. S&P has up to 90 days to decide and will judge whether the compromise offers a “credible solution” to the rising US government debt burden — a downgrade would have wide implications for borrowing costs and global investors.
What did major asset managers like BlackRock say about the debt compromise and why does it matter to investors?
A coalition of investment advisers including BlackRock urged leaders to “fix the deficit for real.” BlackRock — which the article says manages about $US3.6 trillion — applauded the compromise but cautioned the exact makeup and timing of spending cuts will determine whether the deal achieves a meaningful deficit reduction. That matters to investors because credibility and timing shape market confidence, rates and asset prices.
How did commodities and safe‑haven assets respond to the easing of default fears?
With fears of a US default abating, the article reports crude oil prices rose and the Australian dollar strengthened, while gold — which had hit record highs the prior week — slumped as investors reduced demand for safe‑haven assets.
What is the Financial Ombudsman Service (FOS) change mentioned and why should retail investors care?
The article notes ASIC commissioner Shane Tregillis left to become chief ombudsman at the Financial Ombudsman Service (FOS). His experience with market integrity and financial services rules could mean FOS becomes tougher and more effective at resolving disputes between consumers and financial firms — a positive development for everyday investors and people with complaints about banks, advisers or managed funds.
What are “shadow brokers,” and what recent problems were highlighted that investors should know about?
The piece describes “shadow brokers” as lightly regulated firms in broking/managed‑fund spaces that have caused several blow‑ups (examples given: Sonray, Chartwell, Lift Capital). The article reports one shadow broker was reportedly close to appointing voluntary administrators after creditor action, an ASIC AFSL suspension and internal disputes over an auditor — a reminder of counterparty and operational risk in lightly regulated parts of the industry.
What key developments should everyday investors watch next after the debt compromise?
According to the article, investors should watch whether Congress (including the Tea Party faction) approves the deal before deadlines, the special committee’s work to identify further savings, any decisions by S&P on the US credit rating (within about 90 days), and the actual timing and composition of spending cuts and tax moves — all of which will influence market sentiment, borrowing costs and sector performance.
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