The Overnight Report: America Goes Greek

This story features NEWCREST MINING LIMITED. For more info SHARE ANALYSIS: NCM

By Greg Peel

The Dow closed down 140 points or 1.1% while the S&P fell 1.1% to 1305 and the Nasdaq lost 1.1%.

Wall Street was rocked last night when ratings agency Standard & Poor's placed the US on negative credit watch in recognition of the country's mounting debt and stalemate in Congress over what to do about it. From the bell the Dow fell 250 points. US bonds were sold, the US dollar weakened, and risk trades were swiftly removed. By the end of the session, however, a little more thought had gone into the implications.

A weak opening was always going to be a possibility following monetary tightening in China over the weekend via another increase in the required reserve ratio. Citigroup came out with its quarterly result and slightly beat the Street, but it proved not to be a day in which good results were rewarded. Most important, however, were simultaneous events in Europe.

Tiny Finland is not a country which hits the headlines much but its national election held over the weekend has Europe in a lather. Counting showed the peripheral True Finns party, which is anti-euro, could take some 18% of the vote and a balance of power. Given the eurozone bail-out of Portugal requires all seventeen members to comply, and Finland is one of those, the risk is that the Finnish parliament will fail to win approval.

Meanwhile Greece was busy trying to deny rumours that it had approached the EU and IMF to talk about a restructure of its debt. While many in the markets now believe restructuring of peripheral eurodebt is inevitable, the reality still causes grief. Sovereign yields blew out even further, upsetting an auction in Spain and forcing higher yields to be paid for 12 and 18-month Treasury bills.

On European issues, the US dollar had been stronger and US bond yields lower before S&P dropped its bombshell. But the question is: was it really a bombshell?

You would have to have been living in a cave for the last three years not to know the US has a major debt problem, and that recently arguments between the Administration and Congress over how to deal with the problem meant the government came close to shutting down. If it were any other country, markets would have been wondering why S&P hadn't moved to negative watch already. But then again, ratings agencies are renowned for being so far behind the curve they are actually dangerous.

And on that basis, some are suggesting S&P is simply covering its backside in making the rating adjustment, given the company so completely and utterly stuffed up the whole subprime issue. There's also another way of looking at it.

A spokesperson for S&P this morning played down the negative watch and made comparisons to the UK. With debt running at a similar relative level to GDP, S&P had previously placed the UK on negative watch also. The result there was a swift and stringent austerity package passed through parliament which has pulled Britain back from the brink, and led S&P to return the country to stable status.

The thought in America's case is therefore: maybe this is just what the politicians need. The US has been on negative watch before – back in 1996 which was also the last time the government actually did shut down in similar Congressional stalemate circumstances. There is now a fresh impetus to resolve disagreements and arrive at a package of sufficient cuts to appease the ratings agencies. In other words, the government has just been given a swift kick up the Khyber.

And so it was that the stock market turned, slowly, over the course of the day. The Dow recovered more than 100 points. The contrast between America's hardly surprising negative watch and Europe's worsening problems was soon reflected in a turnaround for the US dollar, and indeed a strong rally. The US dollar index finished up 0.9% to 75.50.

US bonds staged a similar turn around, and the ten-year yield finished down 4 basis points to 3.38%. The bail-out of stocks was accompanied by a similar divestment of commodities, spurred on by the stronger US dollar. Brent oil lost US$1.84 to US$121.81/bbl and West Texas was also down a couple of bucks. All base metals fell 1-2% in London with copper down over 1%. The Aussie dollar slipped half a percent to US$1.0509.

Gold, however, bucked the trend in rising $9.50 to US$1496.20/oz. Silver was also higher. This time it was not an indiscriminate flight to cash, albeit gold trading was very volatile last night. A lower credit rating should imply a weaker US dollar, and thus stronger gold, but the dust is yet to settle.

Perhaps the most telling market last night was that of the VIX volatility index. The VIX did spike from 15 to 19 on the S&P news but drifted back over the session, settling at just under 17. While that's still a 10% jump, a level of 17 is still in complacency territory, not panic territory.

So the conclusion is that while a ratings warning is not something one would normally welcome, there are those on Wall Street who believe it might just prove to be a positive catalyst.

The SPI Overnight lost 48 points or 1.0%.

The RBA will release the minutes of its last meeting today and Newcrest ((NCM)) and Woodside ((WPL)) will provide quarterly reports. Tonight in the US sees reports from Goldman Sachs, Intel (Dow), IBM (Dow), Johnson & Johnson (Dow), Yahoo and coal producer Peabody Energy. 

[Note: All paying members at FNArena are being reminded they can set an email alert specifically for The Overnight Report. Go to Portfolio and Alerts in the Cockpit and tick the box in front of The Overnight Report. You will receive an email alert every time a new Overnight Report has been published on the website.]

Click to view our Glossary of Financial Terms