Forex Flash: What happens if we fall off the “cliff” – Westpac (Barcelona) - “Some Republicans may be chastened by Mitt Romney’s loss in the presidential election but they are firmly in control of the House again (a majority of at least 15 seats as 7 seats remain undecided). Hence the same key players who brought the US to the brink of default in August 2011 and failed spectacularly to reach a compromise in the Supercommittee in November 2011 are again facing each other across the table.” warns the Westpac Analyst Team.

According to the Team, “Boehner has a reputation as a dealmaker, but he is under great pressure not to compromise on taxes from the Republican base (including the Tea Party), which reelected his party to a House majority. The prudent, sensible decision is for both sides to find common ground, but then that was also true in 2011 and it didn’t happen.”

We have seen repeatedly since 2007 that bad news for the US economy usually translates to USD strength (along with JPY) as the liquidity of Treasuries dominates. This was certainly the case in the Aug 2011 debt ceiling and downgrade debacle. “Hence a failure to reach agreement, while causing maximum economic damage, would probably support Treasuries, USD and JPY while hurting AUD, NZD, EUR, equities etc. Of course the Treasury rally would be consistent with the sharp hit to growth and indeed delay in the timing of the debt ceiling decision, as taxes jumped and spending slumped (second round effects - including via a slide in confidence - would soon limit the improvement in the budget position).” they predict.