The much-feared downgrade of the US’s sovereign credit rating over the weekend unleashed turmoil in Asian equity markets on Monday but, perversely, increased demand for US government debt and the US dollar.
US Treasuries rose in Asian trading as investors fled to the traditional safe haven, even though worries about the US economy and its fiscal position are at the heart of the global market concerns.
At the same time, equities tumbled. By mid-afternoon in Hong Kong, the FTSE All-World Asia Pacific index excluding Japan was down 3.6 per cent, deepening last week’s 8.5 per cent tumble amid a global market rout. Stock index futures suggested that markets in Europe and the US would also decline sharply when they opened for trading later in the day.
“It doesn’t feel like the downgrade itself has broken the machine,” says Christian Carrillo, an Asian rates strategist at Société Générale. “It’s risk aversion. Governments doing around world are biasing towards more austerity and fiscal austerity is likely to hurt growth.”
A plunge in global equity markets last week, the biggest since Lehman Brothers collapsed in 2008, was driven largely by fears the global economy is slipping into a recession. Slower growth around the world would make the large amount of public and private debt weighing on the US and Europe all the more burdensome.
“The US downgrade is a symptom of the gradual crumbling of the developed world,” says Dariusz Kowalczyk, Hong Kong-based currency strategist at Crédit Agricole.
After US markets closed on Friday, S&P downgraded the US government’s long-term credit rating to AA+ from AAA– the first ever downgrade of the country by a leading rating agency.
While the move was widely anticipated, there has been great anxiety about its potential consequences because the $10,000bn US government debt market is the cornerstone of the global financial system.
The downgrade was “precipitous, wrong and dangerous,” says Bill Miller, chairman of Legg Mason Capital. “At best, S&P showed a stunning ignorance and complete disregard for the potential consequences of its actions on a fragile global financial system.”
There are now eighteen countries and seven global corporations with a better credit rating than that of the US government, according to Bank of America Merrill Lynch.
The long-term outlook for the US dollar and US government debt is bearish, said Mr Kowalczyk of Crédit Agricole. Given the downgrade, Asian policymakers may allow their currencies to strengthen against the greenback at a faster rate in order to accumulate fewer US dollars in their foreign exchange reserves, he said.
But in the short term, currency traders reckon the US dollar could rally, as money flees risky assets such as emerging markets equities for the perceived safety of the US financial system.
Indeed, on Monday the dollar rose against many Asian currencies, especially the Korean won, which is particularly sensitive to global risk appetite.
But government bond traders shrugged off the US downgrade. Many pointed to the fact that, a decade after Japan lost its AAA rating, 10-year Japanese government bonds are still yielding only 1 per cent and the yen is as strong as ever.
So far there appears to have been little forced selling of US Treasuries by investors who are constrained to holding only AAA paper – perhaps because rating agencies Moody’s and Fitch both confirmed their US triple A ratings earlier this week. S&P’s downgrade also means little for banks, since US government debt still has a zero per cent risk weighting under the Basel II rules.
Indeed, the yield on the benchmark 10-year US Treasury note – which moves inversely to prices – dropped to 2.51 per cent in Asian trading, from Friday’s close in New York of 2.56 per cent.
Meanwhile, equities in Asia tumbled.
One Tokyo-based trader said that, “from where I sit, it’s not panic, it’s uncertainty. The S&P downgrade is not a surprise per se, but the outcomes are uncertain. We don’t know what implications are coming.”
“While the downgrade should be largely factored into equity markets given the sharp falls over the last two weeks, it does add to the general air of uncertainty,” said Shane Oliver, head of investment strategy at AMP Capital Investors in Sydney. “It also makes the economic outlook marginally less certain.”
That sent governments back into action in an effort to shore up confidence.
The European Central Bank and G7 sent clear signals they would intervene in the markets for Italian and Spanish bonds and foreign exchange respectively in an effort to soothe markets.
In Asia, India’s central bank said it would ensure adequate rupee and foreign exchange market liquidity, in a bid to calm markets. South Korea’s state pension fund and other public funds sharply boosted their purchases of Korean stocks, helping pare losses on the broader market, according to Bloomberg.
In Japan, Yoshihiko Noda, finance minister, told reporters that US Treasuries were still attractive assets for Japan. The country is the second-biggest holder of US government debt behind China.
Norman Chan, chief executive of the Hong Kong Monetary Authority, said the territory would stand behind the US dollar in spite of the downgrade and that the currency’s 28-year old peg to the dollar would remain in place as the US was still the most liquid and one of the most stable investment destinations in the world.
Additional reporting by Enid Tsui and Richard Milne
Get alerts on Equities when a new story is published