Both the U.S. dollar and treasury prices are stable, at least relative to the financial Armageddon dragging down global equity and commodity markets, leaving many onlookers wondering how the world's largest government can get away with a downgrade as unscathed as it appears to be. Ten-year treasury yields softened as investors dumped stocks while the government, amongst others, sling mud-shots at Standard & Poor's for its decision to run away with one of the nation's three 'A's.' The answer is quite straight-forward: The policies run from Washington today are no different than they were on Friday, nor are they likely to shift this week or next. S&P has quite rightly called the U.S. administration for its profligate policies and says it's basically on the road to ruin. Investors are not disagreeing with the ratings agency by clamoring for more treasuries but crucially they are increasingly mindful of where the current set of policies is leading. This is why the reaction is abundantly clear within growth-sensitive equities rather than within government securities. Those who claimed that a downgrade would leave U.S. government debt prices in the dust were simply wrong.

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U.S. Dollar - The U.S. might have suffered an embarrassing blow, but it is investors around the world who set the cost of borrowing, and for now there is no demand for a premium. Rather the lower growth trajectory that is now more visible has increased demand for dollars in some quarters. Risk is certainly off the table this morning as investors reflect on policy effect since the financial crisis, seeing the rising cost but little other than moderate growth in the rear-view mirror. The dollar earlier suffered significant losses against bot Swiss franc and Japanese yen but those trends were already in motion to such an extent that last week domestic intervention had already taken place. As equity index futures stage a minimal rebound from heavy losses ahead of the official opening on Wall Street, the dollar index is now higher at 74.67 as it overcomes earlier resistance in the remaining European units.

Euro - The ECB staged an emergency meeting over the weekend and said it would resume purchases of bonds issued by Spain and Italy. By stating that it welcomed efforts made by those governments in an effort to reduce their respective budget deficits, the central bank is prostituting itself to a failing political system within the Eurozone. The ECB recognized after the announcement of a U.S. ratings downgrade that all hell was likely to let loose across Asia and Europe and that lesser Eurozone governments are in far worse shape than the U.S., where maneuverability remains a key benefit. The euro initially reached $1.4400 against the dollar only to slide as investors digested the unfolding dramatic events of the weekend. The euro recently slumped to as low as $1.4201 as the ugly drama plays out. Not helping the tone in the morning was a sharp downturn in the Sentix investor confidence survey for August. The index was predicted to ease by less than two points from 5.3 in July, but in the event a sharp downturn in the expectations gauge between both private and institutional investors caused a dramatic slump in the index to negative 13.5 and the lowest reading since September 2009.

British pound - The pound initially traded up to $1.6459 against the greenback on the premise that it represented one of the few viable safe havens. The British government made sure that within weeks of its election last year it ushered through stringent austerity measures keeping the ratings wolves from its door. That plan has worked reasonably well except for the resulting near-dereliction of growth from within the economy. The pound rose versus the euro, which buys 86.87 pence having reached its strongest since May 27. The employment situation within Britain continues to reflect the resulting fiscal burden on Briton's workers. A Lloyds Corporate Bank employment confidence survey fell by three points to a reading of negative 53 in July as employment prospects and job security both tumbled compared to a year ago among survey respondents. Confidence in the pound took a bashing as risk aversion grew sending the dollar higher to $1.6346.

Japanese yen - The Finance Ministry found itself having to warn speculators that it was ready to engage in a second round of yen sales if the one-sided nature of its currency failed to abate. It's hard to tell apart demand for the safety of the yen and disdain for the dollar at a time when the dollar is pounding higher against growth-sensitive units. Confidence in the Japanese recovery stepped up according to a July economy watchers survey where the current situation improved from 49.6 to 52.6. However, forward-looking optimism fell by the wayside as the index tipped from 49.0 to 48.5 indicating that the prospects six-month forward were fading. The yen recently reached its session high in New York at ¥77.56 while it surged to ¥110.54 against the euro.

Canadian dollar - While the Canadian monetary authorities might actually welcome the recent weakness in the value of the domestic dollar, the fiscal authorities might be feeling somewhat irritated by the apparent lack of confidence in a pristine budget stance. The Canadians are likely to return to deficit well before any other G7 nation, not that you'd guess this from a loss of appetite for the so-called loonie, which on Monday slid to its lowest since June 28. The move, however, comes as part of a broader loss of confidence in risk appetite and reflects greater concern over the prospects for global growth. Key commodity prices have tumbled out of bed on Monday morning with one of those being the Canadian dollar, which at $1.0122 U.S. cents is en route to parity, where it hasn't traded since February. Arguably, the crisis is worse today than it was six months ago.

Aussie dollar - The Aussie is faring worse than the Canadian dollar as risk aversion spreads. Apart from the obvious selling of riskier bets in general, some of that reason belongs to the prospects for interest rates. The Aussie has been cushioned by about four percentage points in yield differential against the dollar as the successful rebound in growth played out. But as growth clouds have gathered on the horizon, investors have been forced to deal with the growing plausibility that the Reserve Bank is likely to prick that cushion to deal with slowing external and internal levels of activity. The Aussie on Monday swooned to $1.0302 U.S. cents to its weakest reading since March.

Andrew Wilkinson

Senior Market Analyst ibanalyst@interactivebrokers.com       

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