WASHINGTON (Reuters) - President Barack Obama said on Sunday that Democrat and Republican leaders have reached an agreement to reduce the U.S. deficit and avoid default, but it was not clear if the spending cuts were deep enough to stave off a credit rating downgrade.
Obama said the agreement will cut about $1 trillion over 10 years and cuts would not happen so quickly that they would drag on the fragile U.S. economy. Another $1.2 trillion would be cut if a joint committee fails to find at least that much in budget savings.
The deal would still have to be passed in the House and the Senate.
U.S. S&P 500 stock futures bounced 1.4 percent and U.S. Treasuries futures slid on news of the deal. Gold and then yen also fell.
Standard & Poor’s and Moody’s rating agencies indicated earlier that deficit-cutting measures of around $4 trillion would be enough for the U.S. to avoid losing its prized AAA rating.
“Definitely there will be a positive market reaction and equity futures are already trading higher ahead of that. Keep in mind that this deal has to pass both the House and the Senate. I think it will pass, but there are still more ideological factions within the parties that have a problem with the deal that has been reached.
“There are significant spending cuts in the plan, but a lot of them are put forward into the future. But the backbone of the plan is to cut spending.
“If the U.S. looks stronger, the dollar is going to be stronger.
“The next question is, was this enough for the ratings agencies? The ratings agencies have said they want $4 trillion. This is almost $3 trillion. Will they look for more progress down the line or revenue generation or will they go ahead with the downgrades anyway?
“If there is a downgrade, if they went ahead with it, I see an immediate drop for equities in the 3 to 4 percent range. For Treasuries in the event of a downgrade, regardless of this plan, I don’t think they would face too difficult of a time because at the end of the day they are the safe haven for the world.
“In the event of a downgrade, equities react negatively but not a huge sell-off in Treasuries.
— S&P had warned on July 14 that there was a one-in-two chance it could cut the U.S. credit rating in the next three months if talks on raising the debt ceiling and cutting spending remained stalemated.
Moody’s and Fitch had also said they will downgrade the U.S. credit rating if failure to raise the nation’s $14.3 trillion debt ceiling left the Treasury without cash to service its debt obligations.
— The U.S. Treasury warned that it could not guarantee payment of all of the government’s bills after Aug 2 without an increase in the federal borrowing limit. But it never specified a date for when the government would actually start to miss payments on its debt or other bills.
— Republicans had repeatedly rejected Democrats’ suggestions that a new deal should include both spending cuts and revenue raising measures such as tax increases for the wealthy. Some Democrats, meanwhile, had resisted any suggestion of deep cuts to popular social programmes.
— Some major bond fund managers have asked their institutional clients to consider waiving strict requirements that might force mass selling of Treasury bonds if the United States loses its AAA rating.
Pension funds, endowments and other large investors typically establish rules governing how their assets can be invested when they sign on with a money manager. Some analysts fear a downgrade of the U.S. rating would spark a mass sell-off because of guidelines that only permit investments in AAA-rated securities.
Compiled by the Asia Economics and Markets Desk