US warned debt deal may not be enough as Dow plunges 2.2pc
The US has avoided a catastrophic default after a convincing vote in the US Senate, but a key ratings agency has warned the world's largest economy that "tough'' choices still lie ahead.
Reaction throughout markets was broadly negative, with many players in the bond market concerned the amount of debt the US is carrying will not fall enough following the deal.
US shares recorded a major sell-off last night with the Dow closing down 2.2pc and the S&P 500 shedding 2.56pc.
Fitch, one of the big three agencies, said that while the chances of a US default were extremely low, the country needed to confront "tough choices'' on tax and spending. The agency said the US is under review, with results due this month.
President Barack Obama signed the debt-limit compromise that prevents a US default after the Senate voted 74-26 for the measure, which raises the nation's debt ceiling until 2013. It also threatens automatic spending cuts to enforce $2.4 trillion (€1.7tn) in spending reductions over the next 10 years.
Despite the progress, a string of economists and bond market players lined up to dismiss the compromise and warned that the US has not done enough.
"We may have made things worse,'' said Mohamed El-Erian of Pimco, the world's largest bond fund with billions under management. "We have not made a major dent in the debt stock,'' he claimed. He described the package as a "stop-gap measure'' in an interview with the 'Wall Street Journal'.
The compromise legislation defers decisions on the nation's finances to a bipartisan panel of lawmakers and may reduce government deficits only modestly while slowing economic growth.
"The push and pull Americans saw in Washington these past few weeks was not gridlock," said Senate Republican leader Mitch McConnell.
"This bill does not solve the problem. But it forces Washington to admit that it has one."
The positive news about a deal was also overshadowed by broader economic news from the US where consumer spending unexpectedly dropped in June for the first time in almost two years and savings climbed, adding to evidence that the slump in hiring is hurting household confidence.
Purchases fell 0.2pc after a 0.1pc gain the previous month, Commerce Department figures showed in Washington. Incomes grew at the slowest pace since November.
The lack of jobs, combined with wage gains that have failed to keep pace with inflation, raise the risk of further cuts in consumer spending, which accounts for 70pc of the world's largest economy.
The House voted 269-161 on Monday for the deficit-reduction measure, which raises the $14.3tn debt ceiling enough to fund the government until 2013 and threatens automatic spending cuts if a bipartisan congressional committee doesn't identify reductions that Congress will accept.
"Finally, Washington is taking some responsibility for spending money we don't have," said Lamar Alexander, the third-ranking Senate Republican. "This is a change in behaviour from spend, spend, spend to cut, cut, cut."
Second-ranking Democrat Dick Durbin said his vote for the plan "does not come without pain" because it would reduce funds for disease research and education programmes for poor children. Lawmakers must "be prepared to raise revenue" in future efforts to cut the deficit, he added.
The legislation falls short of the long-term deficit savings that Mr Obama initially sought. The political obstacles to reaching even the lower target are formidable, though the measure's sanctions improve prospects "a bit", said Peter Orszag, Mr Obama's former budget director.
Meanwhile, there was some confusion over whether US Treasury Secretary Tim Geithner would stay on following the key vote. He had previously signalled he might depart from his post once an agreement was delivered. "I haven't made that decision yet," said Mr Geithner.