Extending US govt debt ceiling for three months could help stabilise a greenback under severe pressure of late

President Trump has struck a deal with the Democrats on hurricane aid, government funding until December, and a suspension of the debt limit until mid-December

PUBLISHED : Tuesday, 12 September, 2017, 9:12am
UPDATED : Tuesday, 12 September, 2017, 10:33pm

Harvey and Irma haven’t been the only recent hurricanes to hit the United States.

A political storm erupted in Washington as a Republican President cut a deal with Democrats in Congress to extend the US government debt limit for three months.

Yet this combination of events may help stabilise a US dollar that has been under severe pressure recently.

That may sound an odd conclusion. After all, hurricane damage on the scale wreaked by Harvey and Irma are not only a human tragedy but also economically disruptive.

And the three-month extension to the US government’s debt limit may just be an exercise in kicking the can down the road.

But all this has happened with the US dollar already on the ropes, as a glance at the level of the dollar/yuan exchange rate will illustrate.

It could be argued that such is the size and breadth of the currency market’s current bet against the US dollar, that the greenback could be due a bounce, if only short-lived. Positioning looks somewhat extreme.

On the plus side for the greenback, surely, the main currency needed to fund hurricane relief and reconstruction in the United States and the Caribbean is going to be the US dollar.

US insurers will likely be able to liquidate US dollar-denominated assets to free up greenbacks. Non-US insurers may not have that luxury. The latter may have to sell non-US dollar-denominated assets and then exchange the proceeds for greenbacks, just at the moment when the currency market is already heavily short of US dollars.

Then there’s the issue of President Trump’s deal with Congressional Democrats and moderate Republicans that has facilitated a three-month extension to the US government’s debt limit while simultaneously releasing federal aid for hurricane relief.

That deal may, perhaps counter-intuitively, result in a tighter supply of US dollars in the next quarter.

In the first instance, the extension of the US government’s debt limit might give the Federal Reserve more confidence to start on balance sheet reduction on September 20, embarking on quantitative tightening (QT) as opposed to quantitative easing (QE).

QE resulted in lots of headlines about “currency wars” with the US dollars freed up by the Fed’s asset purchases leaching into the global monetary system in search of yield, pushing the greenback downwards. Might not QT, to some degree, prompt the opposite currency effect?

Might it not also be possible that Trump’s newly-revealed bipartisan approach could facilitate the passing of infrastructure investment and tax cuts legislation that then prompt capital flows back into the United States?

Might it not also be possible that Trump’s newly-revealed bipartisan approach could facilitate the passing of infrastructure investment and tax cuts legislation that then prompt capital flows back into the United States?

A market that is so structurally short of US dollars cannot exclude such a possibility. After all Donald Trump does consider himself the consummate deal maker.

Then there’s the issue of what the debt limit extension means for the US Treasury’s day-to-day activities.

US Treasury Secretary Steven Mnuchin said on August 21 that “come the end of September, my magic, super Treasury powers will run out” and that the debt limit issue would need to be addressed. Hey presto, it has been addressed, if only for three months.

In the interim, Mnuchin doesn’t need to use his “magic powers” which, given that the US Treasury has to restrict its issuance of debt the closer it gets to hitting the established debt limit, partly involves the drawing down and spending of US Treasury cash balances held on deposit with the Fed, money that might ordinarily just sit on account.

To put that into context, on August 1 the Daily Treasury Statement showed the US Treasury had an opening cash balance of US$189 billion in its Federal Reserve Account. That had fallen to an opening balance of US$38.7 billion last Thursday when the debt limit extension deal took shape.

That’s money spent by the US Treasury that wouldn’t normally find its way into the global monetary system at such a pace. That’s money that has arguably then gone searching for yield leading to US dollar depreciation as investors move into higher yielding currencies.

But with the debt limit extended for three months, the US Treasury has more room to issue new paper, avoiding the need to draw down on its cash balance held at the Fed. A potential driver of US dollar weakness may well have been removed for the time being.

It’s very possible the greenback’s longer term trajectory remains downwards, but the US dollar has been battered by strong winds for a good while now. Perhaps it’s is due a temporary respite, or given recent events, reached the eye of its own hurricane.