INVESTORS SHRUG OFF U.S. DEBT WARNING / THE FINANCIAL TIMES ( A MUST READ )

Last updated: July 14, 2011 12:53 pm

Investors shrug off US debt warning

By Jamie Chisholm, Global Markets Commentator

Thursday 12.45 BST. Fiscal worries are again dominating the markets, though the focus has switched from the streets of Athens to the corridors of power in Washington.

S&P 500 futures point to a 0.1 per cent advance for Wall Street as traders absorb the implications of a possible Moody’s downgrade of US debt should lawmakers not agree to raise the country’s debt ceiling and thereby potentially trigger a default.

 

Stocks in New York look like getting support from some well-received earnings from JPMorgan and a pop in ConocoPhillips shares after the energy giant said it would split in two.

The FTSE All-World equity index is down 0.2 per cent, commodities are soft to mixed and gold has hit another record of $1,594 an ounce – though is now up 0.5 per cent at $1,589.

The news from Moody’s has been greeted more with a sense of tired confusion than fear, coming as it does at a time when investors are also having to discount continued eurozone budget stress, further political tensions in the Middle East, the start of the US second-quarter earnings season and an uncertain monetary environment after Federal Reserve chairman Ben Bernanke raised the prospect of more quantitative easing.

Adding to traders’ discomfort is the debasement of “haven” as an asset class, the clear definition of which has been a prerequisite for those disciples of the simplistic “risk on/risk off” strategy.

Some in the market argue it is currently difficult to apply the haven moniker to Treasuries, while others clearly remain wedded to shifting funds into Washington’s paper at the slightest hint of stress across other products.

So, ironically, while the dollar initially fell on the prospects for further monetary easing and worries about Washington’s debt ceiling, the US sovereign bond market has stood out as a beacon of calm. Benchmark 10-year yields are little changed at 2.89 per cent, just off seven-month lows.

Thus if the broader market is trying to use the Treasury complex as a guide to prospects for risk appetite, it may struggle to decipher the code.

Are US bonds stable because traders believe the budget discussions will reach agreement before the August 2 deadline? Or is it that the (slim) chances of QE3 from the Federal Reserve are counteracting downgrade worries? Perhaps, it is that investors are so conditioned to snapping up Treasuries in difficult times that they continue to do so even when those very assets are the source of the market’s anxiety.

The upshot of all this is a bit of a strategic mess across financial markets on Thursday. The dollar is flat but gold’s new record speaks to heightened anxiety.

Meanwhile, the FTSE Eurofirst 300 is down 0.8 per cent – reflecting Wall Street’s loss of a big chunk of its early gains on Wednesday. Eurozone peripheral sovereign debt spreads remain near peak levels after Italy auctioned €3bn worth of bonds but had to pay a record premium to get the sale away. Italian 10-year yields have again touched 6 per cent, yet the euro is stable at $1.4193.

One standout performer in recent days has been the yen as its haven reputation has been burnished by comparison with tarnished peers. The Japanese unit sits at Y79.01 to the dollar and the yield on 10-year Japanese government bonds has dropped to an eight-month low of 1.08 per cent following a well-received Y2,400bn ($30.3bn) auction of five-year notes.

A strong yen is not great news for Japanese exporters, however, and the Nikkei 225 lost 0.3 per cent alongside a mostly weak Asia session. The FTSE Asia Pacific index is off 0.2 per cent even after resource groups in the region were helped by higher commodity prices overnight, particularly gold.

Trading Post. It’s shaping up to be a big couple of days for banks in Europe and the US. How they fare may set the market mood for the short term.

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On Thursday, JPMorgan kicked off Wall Street’s second-quarter earnings season, and it is followed on Friday by Citigroup.
Worries over a tougher regulatory environment and dwindling trading volumes have helped push the US banking sector down about 8 per cent in the past 12 months, according to Thomson Reuters, against a rise for the S&P 500 of some 20 per cent.

Many believe that for the broader stock market to make much more headway, the financials must revive their leadership credentials.

The good news for bulls is that the market looks to have set the bar quite low, and the early reaction to JPM’s results looks promising, with the shares slated to pop at the open.

But perhaps more critical to investor psyche is what happens across the pond on Friday, when the new European bank stress test results are released.

Here, perception is all. They must be tough enough to command credibility, while not delivering a greater than expected batch of “failures”. They must be sufficiently transparent to allow for quality analysis without encouraging speculative attacks. A difficult balance.

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Copyright The Financial Times Limited 2011.