FOREX: Yen, Dollar to Rise as Stocks Sink on US Debt Plan Vote Delay

Talking Points

• Yen Gains as US Dithering on Debt Plan Sinks Stocks Overnight
• S&P 500 Index Futures Point to Continued Risk Aversion Ahead
• Euro Slides as Moody’s Puts Spain Under Review for Downgrade
• US GDP Report in Focus on Global Economic Slowdown Fears

Risk aversion overtook currency markets overnight, with the Japanese Yen outperforming and the safe-haven US Dollar and Swiss Franc not far behind as stocks slid across Asian bourses following news that the US Congress will delay a vote on one of the competing plans to raise the nation’s debt ceiling. The MSCI Asia Pacific regional stock index slid 0.9 percent, while the sentiment-sensitiveAustralian and New Zealand Dollars bore the brunt of blood-letting in the FX space. S&P 500 stock index futures – a proxy for risk appetite at large – are pointing sharply lower ahead of the opening bell in Europe, promising more of the same in the coming session.

Broadly speaking, concerns center on the implications of a failure to resolve the lingering impasse for global growth. Indeed, in the worst-case scenario, the markets will punish the US by selling Treasury bonds and pushing their yields higher. This amounts to an increase across the spectrum of borrowing costs for US businesses and consumers, an outcome clearly detrimental for economic growth in the globe’s top economy and thereby the world at large just as the recovery enters a fragile post-stimulus period and looks set to slow, threatening to tip the scales back towards recession.

The Euro likewise came under pressure as headwinds from the overall risk-off environment were compounded after Moody’s put Spain’s credit rating under review for a downgrade. The ratings agency cited continued funding pressures facing the Spanish government as the markets broadly bid up the country’s borrowing costs and interestingly identified last week’s ambitious EU Greek bailout as an exacerbating factor. The logic is straight-forward: the Greek rescue involved swapping some privately-held Greek bonds (albeit under the guise of “voluntary” participation) for longer-term maturitiesimplying Greece defaulted on the originally given obligations and was forced into restructuring akin to that of an individual that has declared bankruptcy.

While the EU has said this will not happen elsewhere, that promise can be withdrawn as quickly as it was given, and markets will be compelled to stress-test other “PIIGS” nations and challenge policymakers’ resolve before resigning to believe in regional stability. Furthermore, the increase in the powers of the EFSF bailout fund did not come with an increase in its size or even a clarification of how it would secure access to what is supposed to be its current firepower. Indeed, the fund only has a bit over half of the promised 440 billion euro meant for its disposal actually on hand. Needless to say, this further encourages the markets to test the waters and see if policymakers can actually come up with the money to back their pledges.

On the data front, a quiet European calendar is likely to pass by with little fanfare as traders set their sights on the preliminary set of US Gross Domestic Product figures. Expectations call for output to add 1.8 percent in the second quarter, yielding the slowest performance in a year. Naturally, the outcome threatens to reinforce already festering global growth concerns, feeding risk aversion further.

Asia Session: What Happened

Euro Session: What to Expect

Critical Levels

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