US downgrade

illustration: new york

(08.08.2011) The rating agency Standard and Poor's has downgraded the US credit rating, from AAA to AA+. This is likely to affect markets negatively over the coming days. At the same time worries regarding the European debt crisis persist.

By Camilla Viland, Analyst at DNB Markets

To calm markets the ECB has signalled that they are ready to purchase Spanish and Italian government bonds, while the G7 has indicated that they are ready to intervene in the currency market, if necessary.

After several disappointing US data released lately, the labour market figures released on Friday came as a pleasant surprise. US payrolls increased by 117' persons in June. Consensus had expected an outcome of 85'. Furthermore the payroll figures from May and June were in total revised up by 56'. The unemployment rate fell, from 9.2 to 9.1 per cent. Despite of better than expected figures on Friday, the labour market is still undoubtedly very weak. Still the figures may dampen fears that the US economy is heading into a new recession. The initial market response to the figures was positive. Stock markets rose, treasury prices fell and the oil price climbed. The figures were however not enough to calm markets, which later turned negative again. International stock markets ended yet another day down.
It is reasonable to expect further stock market declines today after it was known Friday evening that the rating agency S&P had downgraded the US credit rating, from AAA to AA+. S& P say the downgrade reflects their opinion that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than they had envisioned. It is clear that they are not impressed with the way the US politicians handled the raising of the US debt ceiling. This may get US policy makers to tighten fiscal policy further which again will be negative for US growth and further raise fears of a new recession in the US.
The downgrade is likely to affect markets negatively over the coming days; however it is uncertain how large the effects will be. A downgrade from S&P was more or less anticipated and at the same time the US still has the top rating at the two other leading rating agencies, Moody's and Fitch. The effect on US Treasury yields may go in both directions. On the one had a credit rating downgrade normally would give higher interest rates. On the other hand US treasuries are still likely to be perceived as relatively "safe" and there are few other good alternatives. Thus continued market turmoil may keep the demand for US Treasuries high, and thus the yields low. Another possible effect may be increased demand for Norwegian government bonds, which is perceived as one of the safest assets one may own.
Another topic that probably will worry markets this week is continued worries about the debt turmoil in the euro area and fear over contagion to larger countries like Italy and Spain. As a consequence of this yields on 10 year Italian and Spanish government bonds already have risen above 6 per cent. To try to calm the markets, the ECB has signals that they will intervene in the market for Italian and Spanish bonds. In another statement, from the G7 countries, the G7 supports the measures taken by the ECB and say they would take all necessary measures to support financial stability and growth. The statement is seen as a signal that the G7 countries are ready to intervene in the currency market, if necessary to soothe market after the impact from both the euro zone debt crisis and the US credit rating downgrade.
There are few key figures on the agenda today. Later this week, the Federal Reserve Monetary Policy Committee meeting on Tuesday will be of great interest. The big question is whether or not the central bank will indicate a new round of quantitative easing. Norges Bank holds a meeting on Wednesday where they are expected to raise the key policy rate by 25 basis points, to 2.50 per cent.