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By Shavasb Bohdjalian
The euro gained in value and the dollar retreated following a breakthrough in negotiations to raise the US debt ceiling and avoid a default. It is remarkable how both the EU and the US wait until the last minute and at the 11th hour solve problems that should have been settled weeks or months before.
In Europe, solving problems only when politicians are pressed against the wall is the normal way to doing things, but the “decease” has now spread to the US, which also wasted weeks before finding a solution at the last minute, just a day before the Treasury would run out of money.
The plan involves a two-step process for reducing the U.S. deficit. The first phase calls for about $900 billion in spending cuts over the next decade and the next $1.5 trillion in savings must be found by a special congressional committee. Congress must act by December 23, 2011, under the deal.
We still don’t know how the rating agencies will react and if they will be as harsh with the US as they have been with European countries.
If the likes of S&P, Moody’s and Fitch do not downgrade the US, then European nations will have every right to say that the rating agencies are anti-European and biased in favour of the US.
But at least one analyst says the US is not in a dire situation as it seems. As Dan Ferris commented in the Daily Crux, the US could instantly eliminate $1.6 trillion in government debt by simply canceling the debt owed to the largest holder of U.S. Treasury debt, the Federal Reserve Bank of the United States or the central bank of the United States.
Texas Congressman Ron Paul has proposed the Federal Reserve simply cancel the $1.6 trillion in Treasury debt it holds. The Federal Reserve owns the bonds, so the Treasury is paying the Fed interest. The Fed in turn refunds the interest back to the Treasury. This is theatre of the absurd says Ferris.
Until such a simple yet dramatic decision is made, the pressure is on the rating agencies and in turn the US dollar, which even after passage of the compromise agreement should come under pressure.
The euro and commodity currencies such as the Australian and New Zealand dollar should continue to benefit as risk appetite returns while it will be interesting to see if the Central Banks will intervene to stop the rise of the Swiss franc and the Japanese yen, which last week reached record levels.
The record rise prompted a number of analysts, such as JPMorgan to lower their year-end forecast for dollar/yen to 75 yen from 78 yen previously, and are now expecting the dollar to fall further from there to 73 yen at the end of June 2012.
Against the Swiss franc, the dollar recovered, pulling away from a record low near 0.7850 francs hit late last week while the euro/Swiss cross also recovered from a record low of 1.1300.
Come September, things will become even more interesting when the market will start the speculation game as to when and by how much the Fed will start its QE3 program, which in the past has been equity positive and dollar negative.
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(Shavasb Bohdjalian is an approved Investment Advisor and CEO of Eurivex Ltd., a Cyprus Investment Firm, authorized and regulated by CySEC, license #114/10. The views expressed above are personal and do not bind the company and are subject to change without notice. Investing in markets and trading on leverage is highly risky and it may not be suitable to all investors since it carries a high degree of risk and you can lose more than your initial investment)
