AMP’s Shane Oliver has predicted that investor concerns over the US debt ceiling will intensify as the process unfolds, potentially impacting Australia regardless of the final outcome.
Speaking to InvestorDaily on Wednesday, as reports surfaced of US President Joe Biden cancelling his scheduled trip to Australia and holding a productive meeting with top congressional Republican Kevin McCarthy, AMP’s chief economist expressed scepticism about the likelihood of a swift resolution.
“Negotiations have started but there is a long way to go yet, and it may require a share market mini panic to bring the two sides together,” Dr Oliver said.
Namely, according to reports out of the US, Mr McCarthy, the speaker of the House of Representatives, told the media: “It is possible to get a deal by the end of the week. It’s not that difficult to get to an agreement.”
However, the Democrats did not share his enthusiasm, with the White House branding the meeting “productive and direct”.
Republicans have consistently declined to support raising the US debt ceiling beyond its current limit of US$31.3 trillion, conditioning their approval on President Biden and his party’s acceptance of spending reductions in the federal budget.
According to Treasury, the X-date by which the debt ceiling will need to be increased, or else the US government would begin to default on its debts, is as early as 1 June.
The issue previously has been that the Democrats do not want to cut spending as they believe it would add to recession risk ahead of next year’s presidential election.
On the other hand, Republicans, too, cannot afford to not reach a resolution given the negative perception it would have before the election.
As such, Dr Oliver believes that a compromise is very likely.
“It’s a serious issue and we put the risk of a US default on some of its obligations as 10–15 per cent but the most likely outcome is a resolution,” he told InvestorDaily.
“A resolution is unlikely to come until the last minute though — as was the case in 2011 and 2013 when this was last a big issue.”
However, he clarified that even with a resolution, there will still be challenges and difficulties to navigate.
Namely, as the resolution approaches, markets are expected to grow anxious about the inclusion of spending cuts in the final agreement and how this could impact the economy and add fuel to an already, on the cards, recession.
“Once the debt ceiling is raised, markets will also lose the liquidity boost that the US Treasury has been providing since January as it ran down its cash reserves,” Dr Oliver said.
Noting that while the X-date could be later than 1 June, slowing budget revenue flows in the US suggest it is getting close regardless, and markets are reacting.
Reflecting on President Biden’s last minute trip cancellation, Dr Oliver said: “It’s surprising that Biden ever agreed to the trip to Australia now anyway because these things only ever resolve at the last minute and the same is likely this time,” he added.
Either way, Dr Oliver said Australia should brace for impact.
“Either way we will be affected with likely further falls in US and Australian shares in the weeks ahead,” Dr Oliver explained.
“If the issue is not resolved and the US defaults on some of its commitments then the US will probably tip into recession (which is a high risk anyway given rate hikes) and markets would fall further in response to this. A US recession would mean an increased risk of an Australian recession (where the risk is also already high due to rate hikes).
“If there is a resolution, markets could still fall further because any deal will likely require some degree of spending cuts, but the falls would be more limited.”
