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 EUR1 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.