Safe-havens in demand

illustration: DNB markets dealingroom

(26.07.2011) There were some signs of increased uncertainty among financial investors yesterday, after no progress in the US debt-ceiling discussions and as the European debt crisis is looming. In FX, the US dollar slipped versus most currencies in Asian trade tonight.

By Anders Grøn Kjelsrud, Analyst at DNB Markets

The Swiss franc – often referred to as the ultimate safe-haven currency – has gained by around 0.6 per cent versus the euro since yesterday morning, and by well above 1 per cent versus the US dollar. Another indicator of market turmoil is usually the price of gold. During yesterday’s trade the price of one ounce of gold rose to record highs (in nominal terms), to above USD 1620.

The most important US stock indices all closed the day in negative territory – S&P500 down by 0.6 per cent, Dow Jones down by 0.7 per cent. The background for the (small) tendencies of fresh market turmoil is probably twofold: the lack of progress in the US debt ceiling negotiations, and uncertainty about the usefulness of the latest European bail-out package. First to the US.
 
As well known, the US government is approaching the self-imposed limit on how much debt to undertake, the so-called debt ceiling. The ceiling must be raised by 2 August for the government to be able to meet all its obligations, according to the US Treasury. Still, with the “deadline” only a week ahead, there are no signs of an agreement. Yesterday President Obama urged congressional leaders to reach a “fair compromise”.

The dead-locked political conflict probably affects investors to be a little more cautious, fearing that the US might lose its triple-A rating, something the rating agencies for a while have warned could happen. Yet, there are by no means any signs of panic – yields on US Treasuries remain at unusually low levels, the yield on 10-year bonds at around 3 percent.

Admittedly, and as mentioned above, the US currency weakened in the Asian trading session, but it is worth remembering that the dollar remained fairly stable throughout the trading sessions in Europe and the US yesterday. All this suggests that most investors are expecting a last-minute-solution to the debt conflict.
 
The debt crisis in the euro area is another factor that is weighting on the market participant’s optimism. As discussed briefly in yesterday’s report, Moody’s have decided to downgrade its rating on Greek government debt by three notches to Ca, one notch above what is used for a country in default. Fitch did a similar decision last week. Thus, there is little doubt that the rating agencies will evaluate the impact of the recent Greek bail-out package as a (selectively) default, when the debt exchanges with private investors actually are implemented (not very surprising, since the exchanges do imply a default!).
 
But both Fitch and Moody's have said that they quickly will assess their ratings after the debt exchanges have been brought through, so as to reflect the new credit risk. This new credit risk will probably still be considered as relatively high. As Moody's emphasized yesterday, small debt restructurings are often followed by larger ones (for example in Argentina). This is something we can not rule out for Greece. Even though the recent agreement results in a lower overall debt burden, and more favorable loan conditions, the debt level, after all, will still be very high and Greece will still be facing significant austerity challenges.

Another important question many now ask themselves is whether the bail-out package is sufficient to avoid contagion to other and more important euro zone members, such as Italy and Spain. When looking at the market development yesterday it seems like investors are having their doubts. Both the Italian and Spanish government bond yields rose significant, and reversed much of the decline from the end of last week.
 
Yesterday gave no important macro released, and today’s calendar is also pretty slim. Among the highlights are new GDP figures from the UK, and Conference Board’s consumer confidence index for the US.