Last night, Moody's warned that the United States may lose its top-notch credit rating in the next few weeks if lawmakers fail to increase the country's debt ceiling, forcing the government to miss debt payments. This follows up their June announcement that said that any rating downgrade would only be to Aa, (the second highest rating) and it would probably only last for a very short time.
At the same time, word leaked out from the US debt ceiling negotiations that President Obama abruptly walked out of the meetings after telling House Majority Leader Eric Cantor, "Don't call my bluff." According to one Republican aide, "President Obama walked out of the high-level negotiations and said, "I've reached my limit. This may bring my presidency down, but I won't yield on this."
Initially, this generated a frisson of market selling all things US: stocks, bonds and dollar. The moves didn't last as additional stories on the downgrade and debt negotiations neutralized some of the uncertainty.
My view is that the threat of the downgrade puts additional pressure on both sides to make an agreement. As an example, Senate Minority Leader Mitch McConnell's warned fellow Republicans to not help re-elect President Obama by forcing a default and then getting blamed for the problems that will ensue. McConnell wants Republicans in the House to pass his short-term debt extension plan he proposed this week.
As I've been warning, the US debt negotiations will be ugly, but ultimately will yield a deal. If not, US Treasury Secretary Geithner will likely still pay the creditors of the United States (Treasury coupons) before making social security payments. Thereby, he will allow the negotiations to continue and ratchet up the pressure further for a deal.
Unlike Europe, these debt negotiations are by choice and the country has the ability to pay their obligations. This is likely one of the major reasons why US Treasury yields have remained low despite the dire pronouncements of impending doom from both sides in the debt negotiations.
Andrew B. BuschDirector, Global Currency and Public Policy Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. You can comment on his piece and reach him hereand you can follow him on Twitter at http://twitter.com/abusch.