
Mid-2011, the last time the US Congress was paralyzed by the reluctance
of the Republican Party to cooperate with Democratic Party fiscal policy, leading to
a fear, unrealized at the time, that the government would have to stop
functioning because it could not borrow for day-to-day requirements and that
the annual budget could not be finalized, is not really that long ago.
There have been one or two changes since then. For one thing, Barack Obama
has been returned as US President for a second term. This is bad for those who seek a compromise,
because he cannot run for a third term and therefore does not have re-election
pressure on him to agree to half measures on his policies. There is also the
perception, at least, that there is light at the end of the economic crisis
tunnel. The Republican Party’s supporters will not thank them for placing that in jeopardy.
And there is some unfinished business since 2011. At the height of that
debt ceiling battle in Congress, Standard and Poor's downgraded the credit
rating of the United States .
It was the first time in history that any rating agency had done that, and it has
never been reversed. What happened in the markets is instructive. Fears for
global instability drove money into US government bonds (even in a crisis, the US was still then
regarded as the ultimate safe haven, which highlights the absolute irony of all
this). Such a development, in turn, reduces bond yields (a proxy for interest
rates) and leads to a reduction in US dollar strength.
But is it possible that, on this occasion, with the prospects in other global
economies on the rise, a downgrade by other agencies would trigger a flight from US treasuries this time
round, which would have exactly the opposite effect, a raising of bond yields
and a consequent dollar rise? This would tie in nicely with the medium to long
term expectation that, whatever about recent events, Quantitative Easing (QE)
will be discontinued, leading to a dollar rise, and the only thing that is
unknown right now is the timing for this.
The ending of QE (QE2 had started in 2010 and QE3 was yet to come) is
another thing that was not in prospect in 2011.
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