If ever there was a pivotal moment for financial markets, this could be it: The United States defaults and investors face the great unknown, or it doesn't and one of 2011's key risks is removed. Not that the coming week does not hold other events of note. There are central bank rate decisions and a raft of significant economic reports, for example. The eurozone crisis is also rumbling on.
But far and away the most important issue for investors is Tuesday's deadline for Washington to raise its $14.3 trillion debt limit. To investors' dismay, approval is being held up by a bitter partisan squabble between Democrats and Republicans.
Without agreement - and there was little sign of one, heading into the last few days - the vaunted triple A-rated US economy could default by not paying all its bills, at least temporarily.
The issue for investors is that what happens next is unclear. For one thing, the August 2 deadline is not necessarily inviolate. For another, the US Treasury could decide it was a priority to keep paying its debt obligations, avoiding any short-term default. In theory, however, lack of agreement could prompt turmoil on financial markets, with investors selling US debt, dumping other dollar-denominated assets, running away from global risk assets and scrambling into already overcrowded safe havens.
Gold , for example, has risen close to 10 percent in July alone, hitting a series of all-time nominal highs as investors have fled the twin US and eurozone debt crises. Similarly, the Swiss franc has soared against both the dollar and the euro in the month. "We are suggesting that there could well be some more volatility. But we are not inclined to believe that volatility will last long," said Kevin Gardiner, managing director of research and economics at Barclays Wealth.
He said there might even be some opportunities created if assets such as US equities react negatively, making them cheaper. A default, nonetheless, would raise huge questions about the supposed sanctity of the world's largest economy, triggering immense stress on US money market funds, tempting banks to stop lending to each other as in the Lehman crisis, and potentially tipping the country back into recession. If, on the other hand, negotiators in Washington succeed in raising the debt limit, an argument can be made that a relief rally of riskier assets would be in order.
Some of the pre-deadline positioning would almost certainly unwind, for example.
Investors clearly want to start raising their risk profiles. Reuters asset allocation polls released in the past week showed a moderate rise in equity exposure for the second month in a row.
At the same time, returns on mainstream assets this year, while poor, do not come close to reflecting the kind of news that has been thrown at them, from Japan's earthquake and tsunami to the eurozone crisis and turmoil in the Arab world. What has been holding investors back most recently are the twin debt crises. If agreement is reached in Washington, that could combine with the Greek bailout agreed by the eurozone to lift some of the barriers.
"I think they are going to come up with something. There will be a certain amount of relief. There will be a bounce," said Christopher Potts, head of economics and strategy at brokers Cheuvreux.
But he said that for a longer-term return to the bull market, signs of diminishing inflation in emerging markets and better growth in the US economy were needed. The debt issues, indeed, are not going to be solved simply by an agreement in Washington and the eurozone's second rescue package for Athens.
Comments
Comments are closed.