FX Weekly Report (02-08-2011): US agrees debt ceiling deal

By Gaurav Kashyap, Alpari ME DMCC

Naturally the announcement has removed a great degree of risk and uncertainty from the markets - atleast until the beginning of 2013 at which point we will approach the $16.7 trillion debt ceiling again. In the interim, focus will shift to the rating agencies and their reaction to their plan. Back in mid-July the S&P had reiterated that any deficit reduction plans should amount to a total of $4 trillion, well above the amount agreed upon this morning.

Technically, this would suggest that the S&P would go ahead with the downgrade, but the assumption is that would be under tremendous pressure not to do so. Perhaps a change in the rating outlook will get their point across, without upsetting too many involved.

Serious questions over US future growth

With the deal taking us through to 2013 before the debt ceiling issue resurfaces, serious questions regarding the future growth of the US will become more central. According to statistics from the Congressional Budget Office, the US debt limit could exceed $25 trillion by 2021 if current laws remain in place and this would amount to a public debt of 101% of the US GDP; and 190% of US GDP by 2035. The proposed spending cuts - the $917 immediately, followed by $1.5 trillion in announced cuts by the end of the year, could have a severe drag effect on future US growth prospects.

The market's reactions to the announcement were expected, in large part. Immediately following the deal, a fresh influx of improved risk sentiment came pouring back into the markets and equities and currencies moved higher on the news. The Nikkei close higher by +1.34%, the FTSE 100 was +1.44%, and US futures were higher at the time of writing. The performance of the traditional safe havens wasn't as clear cut.

After opening Monday's trading session weaker, the Swiss Franc, Japanese Yen and Gold, all of which posted record all time highs against the US Dollar in trading last week, continued building on last week's gains against the Greenback. The Swiss Franc hit a new all-time low of 0.7815, the Yen moving back below 77 levels and Gold trading just under 1620 per troy ounce.

Debt deal now out of the picture

With the debt deal moving out of the picture, we turn to the more traditional drivers of event risk. This week sees a host of macroeconomic releases; Friday sees the release of the all important nonfarm payrolls jobs report from the US and we await the rate decisions from Australia on Tuesday, followed by the rate decisions from the UK and the Euro-zone on Thursday.