The currency blog

UK credit rating outlook under scrutiny

Triple- A worries also mount in the US extending dollar losses

Dollar index near a 5 month low

Yesterday we saw incredible volatility in the markets as firstly Standard & Poor’s said it was revising its outlook for Britain’s AAA credit rating from “stable” to negative. This had a whirlwind effect on the markets with the FTSE falling nearly 3% and sterling tumbling across the markets. Official data showed that the treasury borrowed £8.5 billion last month and the S&P warned that the debt rating would be downgraded if the next governments’ fiscal plans do not show a secure downward trajectory in the medium term. A downgrade would be a huge blow to the status of Britain and would lead to the Treasury being required to pay higher interest on future borrowings. Sterling weathered the initial dip of 2% against the US Dollar and 1.5% against the Euro and retraced back to earlier highs of 1.58 against the USD in later trading and gained some of its losses back on the Euro. Moody’s later informed the market that they had no plans to change their current rating of AAA and stable helping the pound. The response from the UK government and head of the DMO affirmed “There are significant uncertainties in the global economy at the present time and S&P point out that the outlook could be revised back to stable ‘if fiscal outturns are more benign than currently (they) currently anticipate’,” – let us hope Mr. Darlings growth forecasts are correct!

Sterling’s gain back against the US dollar was also helped by worries that the US will eventually face the same fate of a credit downgrade with its spiraling budget deficit and weakening economy. Bill Gross the co- CEO of PIMCO a large bond firm told Reuters that investors fear the US is “going the way of the UK-losing AAA rating, which affects all financial assets and the dollar”, the growing fears sent the dollar tumbling as risk aversion encouraged investors to seek new harbours- the YEN and the EURO the initial favourites. EUR/USD is now approaching the 1.40 level and is still looking bullish. The decline in the dollar comes amid rallying commodities, equities and corporate bonds, initially the increased confidence in the markets encouraged the “safe haven” dollar to be sold, however now the dollar seems to be losing its shine as a safe haven. The dollar index which tracks the US currency against a basket of currencies has fallen to its lowest level since December 29 and has technically broken out of its upward range. Expect to see more dollar weakness with neither risk appetite or risk aversion being dollar positive.

In other news data today confirmed that GDP in the UK dropped 1.9% in the first quarter of this year- this was exactly in line with forecasts and has not moved the markets. Japan has upgraded its economic outlook and is forecasting that exports are forecasted to pick up- this follows a massive fall in exports in Q1 and a 4% fall in output- this should be Yen positive as it underlines the safe haven status of the Yen and will encourage more Yen leveraged carry trades- particularly into AUD.

Finally the Indian Rupee advanced on sentiment that Prime Minister Manmohan Singh will look to sell state assets and attract foreign investment- the INR made its biggest weekly gain against the USD since March 1996.

Discuss on this on the Currency Exchange Forum