S&P Cuts US Debt Outlook

Standard
& Poor’s cut the outlook on US sovereign debt for the first time ever from
stable to negative although retaining the current ratings at their highest
possible levels of AAA and A-1+. The adjustment was explained as being a
warning to the US
that its constantly swelling debt pile was unsustainable and that corrective
measures would need to be introduced immediately. The negative outlook implies
that if nothing changes in the next 2 – 2 1/2 years, then an actual downgrade
has a 1 in 3 chance of being triggered. It is by no means certain that this
will occur, but should shake up opposing US politicians enough to start the
remedial action moving forward. Suffice to say, the announcement provoked a
flight from risk. Equities fell, bond yields rose, commodities came off and
with them, the commodity based currencies such as the AUD and CAD. Gold and
silver both rose, as did the Swiss Franc and oddly, the US Dollar. The news is
now old and largely irrelevant to today’s trading so we are back to the factors
that were affecting the market yesterday morning – Eurozone debt issues, the
Libyan situation and Chinese economic policy.

We
are still getting mixed messages concerning a possible Greek debt restructuring
with Jurgen Stark, an ECB Executive Board member commenting that debt
restructuring is a very costly process and that it creates more problems than
it solves. An EU source stated that Greece had accepted that a ‘mild’
restructuring of its debt was unavoidable. ECB President, Trichet, when asked
about the subject this morning, fended off the questions saying that Greece should
concentrate on applying the aid plan. Market participants however, remain
firmly in the ‘glass half empty’ camp waiting for confirmation of some degree
of debt adjustment. Greece are attempting to raise just over €1 billion today
via a short term bill auction and the outcome of the sale will be crucial to
market thinking going forward and bond yields are telling the story. The Euro
remains vulnerable to developments from the Greek situation.

Sterling has benefitted from a
less risky perception and as such, a lack of a rate hike in May/June should
have little adverse effect on the currency. The minutes from the Reserve Bank
of Australia’s
last policy meeting weakened the AUD with current interest rate levels deemed appropriate
for the medium term outlook, but that the effects of the severe flooding on GDP
would turn out to be more negative than first estimated. These comments added
to downwards pressure on the currency already being exerted by weaker commodity
prices.

We
have seen strong Eurozone PMI data already this morning which will add to the
certainty of a further rise in Euro interest rates, and sooner rather than
later, despite the fact that the bulk of positive activity still emanates from
Germany. The Euro is still clinging on to most of this year’s appreciation, but
with sentiment beginning to falter, a test of 1.40 on Eurodollar could be on
the cards. Other data today is sparse with US housing starts the only release
that catches the eye.

Report
by Tim Lewis