US debt hopes spur optimism

Australian stocks have joined a worldwide rally on financial markets, as hopes grew that US political leaders were moving closer to resolving a budget deadlock and averting an unprecedented debt default.

Australian stocks have joined a worldwide rally on financial markets, as hopes grew that US political leaders were moving closer to resolving a budget deadlock and averting an unprecedented debt default.

Asian markets rallied across the board by more than 1 per cent as President Barack Obama and Republican leaders met for the first time to try to resolve the fiscal stalemate, which has seen the United States government in shutdown for more than a week.

A possible deal could see a short-term extension of the US debt limit as negotiations over the budget continue.

The benchmark S&P/ASX 200 closed about 1.6 per cent higher to 5230.9 points on Friday, one of its best-performing days in months. The broader All Ordinaries rose 1.6 per cent to close at 5228.8.

South Korea's KOSPI closed 1.2 per cent higher, and Japan's Nikkei 225 ended Friday 1.5 per cent up.

The rally, which was expected to be echoed by European markets, came after a week of nervousness among investors as an October 17 deadline for the raising of the US debt ceiling loomed closer. Despite the relief rallies, analysts said the negotiations were still at an early stage and it was not yet clear when or how the political differences would be bridged.

"What's happened is the politicians realise that [the debt ceiling deadline is] less than a week away now ... and they are starting to behave more constructively," JPMorgan chief economist Stephen Walters said. "But remember, we don't have a deal yet."

Economists have warned that the US government shutdown, due to enter its second week, was directly hitting local economic activity, and could also led to a drag on other economies.

"The longer it takes to reach a resolution to the impasse, the bigger the drag on growth, and the harder it will be to accurately gauge the state of the economy," ANZ economists said.

Global markets have not yet moved into a full panic over a potential default, with most analysts tipping a compromise before Thursday's deadline.

In recent days, though, investors have been positioning for the possibility that the government might delay some payments on short-term government debt in the days after hitting the debt ceiling.

Money market funds and banks, in turn, were dumping short-term government debt, known as Treasury bills, set to come due in October and November.

At the same time, the price for credit default swaps used to insure investors against in United States government debt have started to move higher in recent days.

The lack of a political resolution has already hit confidence in the US, with Americans becoming more pessimistic, according to IBD-TIPP and Gallup measures of confidence.

"This is sowing the seeds for a much more material real activity impact," Westpac economist Elliot Clarke said.

"With household consumption growth soft and the housing market under pressure from higher rates, the deterioration in confidence is a very unwelcome development."

Mr Walters said a US default would have a profound impact on financial markets, as the US dollar remained the world's reserve currency.

"The bonds of the world's reserve currency are in default, and that has very serious implications for the rest of the world," Mr Walters said, referring to about a possible default by the US on its debt obligations.

"We can't really work out what would happen on financial markets because I don't think anyone really thinks that's going to happen.

"The impact is just too ugly to contemplate."

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