Despite the impasse in Washington, the US economy continues to improve moderately, even though the partial government shutdown will trim GDP growth in Q4. Gauging how the US economy is travelling has been complicated by the absence of some official data (delayed until full government services resume). However, the remaining Federal Reserve and private sector data reads point to GDP growth running close to 2.5% annualized growth clip in Q3 settling back to 2.0% in Q4 providing the partial government shutdown does not last much longer and importantly, providing the Washington stalemate is resolved ahead of US Treasury’s funding “line in the sand” of 17th October, after which the US may technically default on debt maturing later in October.

Notwithstanding the failed Senate vote to extend the debt ceiling over the weekend, our view remains that an extension of the debt ceiling will occur before the Thursday deadline, mostly because of the potentially very big downside risks to US growth and asset prices if the US technically defaults. The US has been in a position of technical default before, at the turn of the 19th century when the young nation refused to meet the debt obligations of the states and arguably again in 1933 when US Treasury refused to repay in gold on government debt lines that stipulated an option for repayment in gold. Neither example provides any guide to what may happen in the current situation where US debt securities have become the ultimate low risk asset, key to global wealth management products and effectively collateral for bank systems running to many trillions of US dollars.

Neither President Obama or the Senate have a mandate to create potentially a worse version of the 2008 global financial crisis, or one would imagine would want the opprobrium of such a mandate, even to score budget points from their opposition. Also, at the core of the current Washington dispute is a fallacious argument that the US budget needs to be tightened further. The US budget deficit peaked at 10% of GDP in the 2011 fiscal year and in the fiscal year just finished (2013) appears to have narrowed to 4.9% of GDP. On current budget proposals the deficit looks set to moderate to 2.9% of GDP in the 2015 fiscal year. In short, the headwind to US economic growth already runs to 7 percentage points of GDP growth over 4 years in an economy showing only modest signs of recovery.

On the bases of the enormity of triggering technical default and the degree of budget tightening already in place there would appear to be plenty of room for a sensible compromise on the debt ceiling and the budget even among the unusually strange factions bedeviling the current US Senate. On whatever compromise occurs, much as risk assets rallied strongly on hints that the Washington protagonists were starting to talk to each other, our view is that further rallies are likely on an actual compromise solution.

Once Washington wrangling is taken out of the mix, what is left is a US economy with the potential to grow moderately for years to come. Aiding the outlook, the US Federal Reserve (Fed) is in leadership transition from dovish Ben Bernanke to even more dovish Janet Yellen. There is little likelihood that the Fed will start

to taper its $US85billion a month asset purchase program this side of 2014 and it may be well into the New Year before tapering asset purchases becomes a serious possibility. Meantime strong profit growth continues for US companies as the start of the current Q3 earnings reporting season attests and there are good reasons – slowly improving international and domestic markets, low energy costs, low wage costs – to expect the next few quarterly reporting seasons to be favourable as well.

Outside the US, indicators are a little more mixed, but in broad terms Europe continues to recover, China is set to report annual growth around 7.8% y-o-y in Q3 later this week and Australian leading indicators of economic activity remain promising. Pity about the US politicians, but belatedly and dangerously close to an important line in the sand, they look like producing a deal