Sunday, August 7, 2011

The U.S. Rating Downgrade: Financial Earthquake

Stunning? You bet! Unexpected, not at all.

The lowering of the ratings of the U.S. treasuries by Standard & Poors (S&P), could now lead to an earthquake in global financial markets, the consequences not at first measurable. This is an unprecedented event in the history of financial crisis. The U.S. Treasury bond no longer posseses top ratings, a privileges held by only a  handful of countries (Germany, Canada, Switzerland, Holland, Austria, etc.). 
The loss of an "A" in the ratings means there some risk of default, and thus, many institutions now cannot keep Treasuries in its portfolio. These are central banks, pension funds, insurance companies and conservative funds. Treasuries also come as security (collateral) in repurchase other debt. The problem is that there's nothing to replace them. This suggests that the entire market must now adapt to a new situation. In addition, many institutions will not begin the operation of exchange of financial assets right away and will wait for another agency to do the same first.
Either way, the dollar will lose value relative to gold and other currencies. Whenever this happens, commodities (especially oil and food) price increases, as they generally set in dollars. Strong inflationary forces can be seen, possibly only lowered by a drop in demand caused by recession. 
A massive rejection of Treasuries will increase your income (yield), because less money will buy the same title, which pays fixed interest. Whenever this happens, conditions are established for higher interest rates. 
We must now see how the Federal Reserve, which recently warned that a lowering of the quality of U.S. debt would be "unacceptable and unsustainable." will react. They meet on Tuesday. QE3 on the way? Currency wars to escalate?

In the meantime, G7 leaders once again state that they will whatever it takes". Seriously? 

(Based on O Estado de Sao Paulo, Sunday edition)

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