Okay, the rating agency Standard & Poor’s did not actually downgrade America’s AAA credit rating, but we had to make the pun work. Nonetheless, the news that S& P has downgraded its outlook for the US economy from stable to negative is still quite astonishing. Perhaps even more so as the US is showing signs that its economy is recovering quite impressively in many areas; so what has brought this criticism on?
Quite simply, the US trade deficit is enormous. Last Tuesday, it was announced that the US trade balance showed a -$45.8B deficit, well above forecasts. The argument is that this level of public finance deficit is simply not sustainable even for an economy as strong as the US. Adding to this problem is the fact that the opposing political bias between the Senate and Congress means that attacking the problem with any degree of efficiency or success is proving very difficult. As an FT Alphaville blog notes, the US political impasse may last until next year’s Congressional elections, and an appropriate budget will probably arrive late in 2013.
In a Forbes blog, S & P’s move was described as a “false alarm.” But as is later noted, this is only the case if the market is convinced of this fact. If the market gradually considers US Treasuries to be a riskier asset on the back of such rating agency scrutiny, then the US will be paying a much higher premium for its considerable debt. We’re inclined to agree that the market will not lose confidence in the US economy on the back of S & P’s analysis. However, if more follow then the picture changes dramatically.
From a foreign exchange point of view, the US dollar has actually benefitted from the rather gloomy outlook for the US economy. For those of you that followed the yen’s movements in the aftermath of the recent Japanese crisis, this will not come as a huge surprise. The dollar remains a safe-haven currency (though its status as such has come into question in recent months), and so in a time when the world’s largest economy has come into question, investors will flee to safety. Risk appetite will return after the Easter period, and our medium-term view of a weaker dollar remains unchanged. However, unlike S & P, this is based on the Fed’s ultra-loose monetary policy rather than a weaker outlook for the US economy.
As always any comments are welcome, feel free to disagree!
Richard Driver
Analyst – Caxton FX
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