parmveer.sunnar's picture

Today in FX history. 31st July 2011. US Debt-ceiling Crisis

2011 was a particularly volatile year in financial markets with both a European sovereign-debt crisis as well as the famous debt-ceiling crisis in the US. July 31st marks the fourth anniversary that President Obama announced that both political parties had agreed on terms that would see the national debt ceiling raised in exchange for a vast array of spending cuts, in order for the nation to avoid default. The agreement which was drafted stated that $917 billion worth of cuts would be made over the next 10 years, for which the debt ceiling was immediately raised by $900 Billion.

The debt-ceiling crisis was the most volatile week in financial markets since the 2008 global meltdown. The debt-ceiling is the legislative limit on the size of the national debt that the US treasury can issue. Simply put it is the limit on how much money the federal government is allowed to borrow. Had the United States breached this ceiling, the Treasury would have defaulted on their payments to bondholders which would have caused a worldwide crisis to an already weak global economy. We just need to consider the turmoil that the Greek crisis has recently caused in the markets to highlight the significance of a default by a country as globally significant as the USA.

As expected the debt-ceiling crisis as well as the crisis in the Euro-Zone caused an outflow from equities into safe haven assets specifically into treasuries (government bonds) causing the price of bonds to rise. Specifically in terms of stock indices, the NASDAQ, ASX and S&P 500 lost up to 4% in value which marked the biggest fall since July 2009 (the global financial crisis). The commodity market was also hit hard on the back of this crisis with crude oil falling bellow $86 a barrel. As the three charts below show (USD index, S&P 500, WTI crude) highlight, the events leading up to the 31st and shortly after marked a key turning point in the markets.

Charts left to right:USD Index, S&P 500 Index, WTI Crude oil (click to enlarge)