Markets shrug off S&P US downgrade warning; dollar sell-off continues

Tom Tong26/Apr/2011Currency Updates

Financial markets were jolted on Monday, when Standard and Poor’s put the AAA rating of US Treasuries on a negative watch and stated that it saw a one in three chance of a downgrade in the future. The lack of agreement on a path to reduce future budget deficits was stated as the primary reason. Financial markets and fixed-income swooned on the news, but both of them recovered soon after on the realization that there was very little new information in the S&P statements, and that, at any rate, rating agencies had not proven themselves to be particularly prescient in their past calls.

Somewhat surprisingly, the dollar rallied initially on the S&P news, only to fade as risky assets bounced back, and spent the rest of the week trading generally downwards to end at another record low.

GBP

The main news affecting sterling was the publications of the Bank of England rate setting meeting. These were somewhat more dovish than the market had been expecting, as none of the six members who had voted to keep rates unchanged in the previous meeting had changed their minds, and the vote was again six to three. While the rates market rallied on the news, delaying expectations of hikes further into the future, FX markets essentially ignored the release and sterling traded all week more or less in lockstep with the euro, to rise another 1% against the US dollar.

EUR

The dichotomy between strong macroeconomic numbers out of core Europe and deteriorating outlook and spreads for the periphery continues unabated. PMI sentiment numbers held up at strong levels, buoyed by the heavier-weighted core European countries. So called “tier one” peripheral countries (Greece, Ireland and Portugal) saw their spreads blow out to fresh records, while “tier 2” countries (Spain, Italy and Belgium) also performed poorly, though those spreads are holding somewhat below previous highs. The common currency, however, ignored all these negative peripheral news and soared once again 1% against the US dollar, to end the week near the 1.46 mark.

USD

S&P’s negative outlook on US Treasuries last week brought about a short-lived pop in the US dollar, perhaps counter intuitively. However, positive news on corporate earnings quickly overshadowed this, and the combination of buoyant asset and commodity markets with the weakening short-term outlook for the US economy continued to take its toll on the US dollar. In trade-weighted terms, the greenback dropped to a fresh eighteen-year low last week. The US dollar sell-off continues to defy both the gathering macroeconomic clouds in Europe, in the UK and Japan, as well as the increasingly stretched short-dollar positioning in currency markets.

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Written by Tom Tong

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