The Banking and Strategy Initiative

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Crisis Theater : The devil in the US sovereign downgrade

US President Barack Obama and British Prime Mi...

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Inter bank markets will respond first in the debt deal stalemate

Though US treasuries are holding below 3% after every spike when a deal close to agreement gets canceled, markets are preparing themselves globally for the ultimate prospect of a US rating downgrade. The issues critical to the event have changed thus to a never before clarity on the issue still confounding those taking sides on the matter. The UK GDP at 0.5% and credit conditions not yet improved in the developed world to the desired health is one such trigger. The currency markets however, are keeping global markets sane from our point of view, a weak dollar along with results beats at a never before scale meaning buoyant markets till the downgrade actually happens. Once the downgrade happens, US treasuries being held globally there still would not be much of US debt going out on discount sales but Treasury auctions bid cover ratio have dropped from 3.21 to 3.06 for yesterdays 2 year paper auction. Also after the downgrade, the rates on the debt will move up 20-30 bps and maybe 50-60 bps on the short end. As we stand, the only word of caution here is that with borrowing costs rising, banks would have started hoarding longer term paper as later purchases would become likely expensive. This being already in operation, the inter bank market at the overnight front and to 6 weeks could face a drying up of liquidity and as holders of US long debt are global governments and banks, this freeze could impact exacerbation of local factors in each market in Asia, Europe and the USA.

Europe on the other hand has deeper fissures and instability written in large letters

In Europe, with UK and FRance slowing down and France targeted for a ratings downgrade for their fiscal imprudence, the situation is much more critical as Eastern economies prepare to go belly up Turkey freezing currency auctions earlier this week and the governments in Hungary, Romania and other on alert too as once France downgrade issues arise, these countries with EU dependent economies and high amounts of debt without corresponding production (much like peripherals) would be hung out to dry

Really, Higher collateral because its Double A now..Who’s AAA

We also aver, that much like the fond hope of a run on Treasuries in late 2010 since QE2 was going off the table, there is not going to be any substitute for these gilts and thus unlikely that banks would get higher collateral for them More pertinent is the inifintesimal systemic risk in the system equated with AAA grade borrowers as it might well be that systemic risk perception transfers itself to AA borrowers and that in a low interest scenario the futility of trying to make that difference count shines through

The dollar as a currency and Go for Gold 

With the debt deal, foreign exchange markets are much focussed on the Dollar. It is the inherent weakness in the Dollar trading down which is raising hopes for the Dollar economies, making commodities sustain good price levels but mostly causing problems to smaller alternatives like the Swissie. The Swiss Franc is already up to 0.80 cents to a Franc, the concern mostly being for some restructuring nations like Yen, which are unnecessary stuck in an appreciating spiral against the Dollar, now stuck at 77, a never before level and very inconvenient for the Japanese though even there the domestic Economy is growing back faster than required.

A falling dollar discourages selling of dollar assets as investors realise the folly in planning a panic run on the currency and deeper shorts could very well get caught in a vice if they entered now. Also as the other assets priced in the USD become more expensive as was the case during the Oil spike last quarter, other nations esp the emerging countries here in India and China would pay for the dollar follies while the US can consolidate its Exports gains and grow GDP at a consistent positive tick sidestepping the specter of deflation for that Economy ( seeing as Japan was the only other example, yet)

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