Equities rejoice but we cannot brush off shutdown
So the US debt ceiling has risen (at least until February), the US government has reopened (at least until January) and stock markets the world over have celebrated by setting new highs. The FTSE All World index, which set a post-crisis high, or the S&P 500, which reached an all-time high, suggest that the risk of a catastrophic default on Uncle Sam’s obligations to his creditors was never seen as very great. These indices dropped 3.9 per cent and 4.8 per cent, respectively, during the crisis and have rebounded. Indeed, the balance of probabilities was always that the US government would not default. But the outcome was no foregone conclusion. Such can be seen from sharp rises in the yields of one-month Treasury bills – which would actually have defaulted under the disaster scenario – in the first two weeks of October. And it is a little too easy to brush off the incident in the way that the equity market has done. To check for possible damage, it is best to go through a checklist of questions: Has this imbroglio changed the outlook for the Federal Reserve? Yes, but it is only a matter of timing, not of direction. It is now unthinkable that the US central bank could start "tapering" off its bond purchases this month while the extent of the damage is unknown. Given the risk of a fresh imbroglio next year, the chances of a taper in December are also much diminished. If the tapering cannot start until after the February debt ceiling deadline, bond purchases will continue, full steam, at least until March. This helps explain stocks’ reaction. Tea Party Republicans loathe "QE" bond purchases but by their actions they have probably kept QE going for longer. It is hard to believe, however, that the incident will alter the fundamental direction of bond yields and interest rates, which are still due to rise. Has it changed the willingness of foreigners to buy US securities? Quite possibly. This can be seen in both words and deeds. Flows from foreign investors into US stocks have been reducing for months. Meanwhile, China has reduced the pace of its reserve accumulation since the 2011 debt ceiling crisis. If the Chinese news agency Xinhua can publish a piece proposing a "new international reserve currency that is to be created to replace the dominant US dollar", then something is afoot. Selling dollars en masse would be self-defeating – but diversifying into other currencies looks appealing. Has it changed the outlook for profits? Probably by a small amount for the companies most directly affected by government contracts but little more than that. The current earnings season gives companies a chance to alert investors to any shortfalls as a result of the shutdown and so far they are not doing so in significant numbers. Equity investors are betting that profits will be little affected. Has it harmed prospects for US economic growth? Yes. Not by all that much, by enough to make a noticeable difference when growth was already expected to be low. Standard & Poor’s puts the damage at about 0.6 percentage points of annualised growth during the quarter. Barclays estimates that it cost the country about 0.25 per cent of gross domestic product. Has this event reduced the chance of a US default at some other stage? Probably, although this can cut both ways. The fact that markets responded with relative calm might persuade Tea Party Republicans that this is a gambit they can responsibly try again. But against this, their defeat could hardly have been more complete or much more embarrassing. Polls continue to suggest that the as yet untried "Obamacare" is unpopular and that most Americans worry that the nation is too indebted. Competently handled, this episode could and should have been a Republican victory. But it was not competently handled, the gambit was evidently unpopular and a rational political response would be to avoid playing such brinkmanship in future. Whether the political response will be rational remains in doubt. What about the dollar? This must contend with the counter-intuitive behaviour that takes place when the source of trouble in the world takes place in a country that is also its principal "haven". Immediately after the resolution, Treasury yields fell while the dollar dropped sharply. That is partly because the dollar acts as a haven, even when the US is itself the centre of the risks arousing concern. It also reflects the growing unpopularity of the dollar. Foreigners would prefer to hold less of it. A stronger euro, making exports less competitive, is not what the eurozone needs now. But the euro is now at its strongest against the dollar in almost two years, having rallied 7.5 per cent since July. The eurozone crisis has been in abeyance for more than a year. If a stronger euro helps tip Europe back into trouble, the blame will at least partly lie in Washington.