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US Debt Clashes to Continue, Downgrade Likely: Analysts

The US is likely to see its debt downgraded by the credit rating agencies, despite the passage of a bill to raise the country's debt ceiling on Monday, analysts told CNBC.

President Obama and Speaker of the House Rep. John Boehner
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President Obama and Speaker of the House Rep. John Boehner

Pippa Malmgren. president of Principalis Asset Management and a former advisor on financial markets at the White House, told CNBC on Wednesday that the debate and the underlying economic problems in the US are set to persist.

The US Congress voted through a deal to raise the country's debt ceiling by more than $2 trillion, staving off the prospect of imminent default until after the 2012 election. Although the 11th hour agreement has been hailed as a success for the White House, which managed to push back concerns beyond the election season and thereby prevent another potentially damaging stalemate, Malmgren said that it does not solve the spiraling debt situation.

"Instead of $10 trillion (in budget deficits) over the next 10 years, it will be seven. Everybody's doing victory laps over that. From an investor point of view, you don't see the US taking anything like the austerity actions that we've seen for example in the UK," she said.

The agreement is not necessarily an agreement, Malmgren added, as divergent views on key issues, such as taxation, are already emerging.

"It's amazing, a day after the legislation was voted on, (Senate majority leader) Senator Reid says, 'tax hikes are on the agenda'… I don't think there's much agreement here," she said.

The US recovery has been slower than expected during 2011, a situation compounded by a downward revision of GDP growth estimates since 2003. Unemployment remains high, at 9.2 percent, and manufacturing data and consumer spending have been equally weak.

"Many would argue that's why it doesn’t really matter if Moody's or S&P downgrade the United States, which is probably going to happen anyway," Malmgren said. Structural changes are needed, she explained. "The bottom line is that this whole argument will persist, and in the meantime, what can they do to make the economy work better? It's not going to be more liquidity from the Fed."

The threat of a downgrade by the major rating agenciesis becoming ever more present, according to investors, who worry how such an action would affect global markets.

“In the United States, widespread contingency planning is in train to deal with different flavors of policy failure," Percival Stanion, head of asset allocation at Barings, wrote in a note on Tuesday. "We take the view that a deal will get done to lift the debt-ceiling, but it is unlikely that there might emerge a deal of sufficient ambition to avoid the loss of the United States’ AAA rating. We believe the response on the part of foreign public sector money to the possible loss of the US AAA rating is the most crucial unknown factor for financial markets and the path of the global economy.”

Rupert Watson, head of asset allocation, Skandia Investment Group, said the same.

"Although Congress was finally able to reach agreement, confidence in the ability of the US to solve its problems has been damaged," he wrote in a note to clients.

"The US system of government requires the different parties to be able to compromise to reach agreement. However, some of the current incumbents seem willing to risk all to make an ideological point. With the US economy already weak and with problems in the peripheral European economies intensifying, the willingness of some to push the US to the edge of disaster could not have come at a worse time."

For the moment, markets have shifted their attention back to the European sovereign debt crisis. Malmgren said that while this meant that there was the appearance that the US had resolved its debt issues to the satisfaction of the market, it was inevitable that the focus would come back on the US once the committees set up to find budget savings begin to deliberate.

"They'll come back to the US problem. You know the timing already. It'll happen around Thanksgiving. Markets can only deal with one crisis at a time. It's all about playing the timing of when the market thinks the next crisis is coming, but it's not that the crisis went away," she said.

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