US debt talks threaten dollar's safe haven status

If politicians fail to make significant progress on debt talks this week, the status of the dollar as a safe haven asset could be threatened as US financial risks grow.

By Richard Blackden
10:00AM BST 17 Jul 2011
THE TELEGRAPH

The US risks sending tremors through global financial markets and threaten safe haven nature of the dollar and US government bonds should politicians fail to make significant progress on critical trillion-dollar debt talks this week, experts have warned.

President Barack Obama and both the Democrats and Republicans in Congress are locked in fraught negotiations aimed at raising the country's $14.3trillion (£8.8trillion) debt ceiling, or the amount it can legally borrow.

Although the US Treasury has said it will no longer have the money to pay all its bills after August 2, many believe the talks need to deliver results over the next five days to then allow a further week to finalise details and get the agreement voted through Congress.

US government bond investors have so far remained sanguine, believing that American politicians would not risk the government's first default - other than a technical one caused by a procedural mistake in 1979 - in its history.

But as the deadline approaches without a deal, that's likely to change.

"There have been no signs of concern so far," said John Briggs, a bond analyst at Royal Bank of Scotland. "But as we get late into this week, if we don't see good signs then we'll see prices move."

The impasse in Washington is already causing concern among foreign owners of America's debt. China, the biggest holder with about $1.1trillion, voiced its anxiety publicly on Thursday and hoped that the US would protect the interest of its overseas creditors. Neighbouring Japan is the next biggest foreign holder.

Mary Miller, a senior official at the US Treasury, is understood to have spent the past week reassuring foreign investors - who collectively own more than half US government bonds, or Treasuries, as they are known - that an agreement will be struck.

However, the talks have been mired in the heated ideological arguments over how to cut the deficit that are set to be a defining theme of next year's presidential election.

President Obama used his weekly radio address yesterday to argue that ending tax breaks for oil companies and wealthy individuals, such as hedge fund managers, needed to be part of any agreement.

Having wrested back control of the House of Representatives from Democrats last November with a pledge to shrink government spending, Republicans insist that spending cuts need to do the work.

The crisis talks are beginning to echo the difficulty Congress had in passing the $700bn rescue fund during the depths of the financial crisis in September 2008. It took a plunge in US stock markets to see the legislation through.

"I hope they've learnt the lesson," says Mr Briggs of RBS. "I have faith it's going to get done, but this is Washington."

As the talks in Washington have faltered, the US bond market has benefited as investors seek a safe haven from Europe's ongoing debt crisis. Prices for 10-year US government bonds are now close to their highest since December.

But those who work in the market fear that the US risks squandering that safe-haven status as the talks stall.

"We believe that one of the most valuable assets of the US is the safe haven nature of the dollar and US Treasuries," according to analysts at Bank of America Merrill Lynch.

"We believe that any fears of missed payments is likely to threaten this status permanently."

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