Markets spooked, gold shines on US debt fears

ASIAN markets shuddered and gold soared to a record high yesterday after American lawmakers failed again to break the impasse over moves to raise the nation’s debt ceiling and avoid a default.

Talks between Democrats and Republicans on the US debt ceiling had collapsed last Friday and the two sides made little progress towards resolving their differences over the weekend.

The stalemate is reaching a critical stage with the Aug 2 deadline only a week away, before the US government is unable to meet all its obligations like interest payments on debt, social security or pay the salaries of federal workers.

This prompted a warning yesterday from the International Monetary Fund (IMF) that the United States faces a ‘severe shock’ if the ceiling is not lifted.

Republicans and Democrats have started pursuing rival budget plans which are unlikely to win broad support.

House Speaker John Boehner, the top Republican in Congress, was holding a closed-door session late yesterday to push for a two-stage strategy that would raise the ceiling by only US$1 trillion (S$1.2 trillion) in order to force another vote on the issue before next year’s presidential election. House Democrats were also planning their own session.

Deal or no deal, some are warning that the US economy is being damaged by the protracted stalemate. Even if there is no collapse in the markets, investors could lose their confidence in US Treasury bonds and sell them off, which drives down the value of the bonds.

Such unease about the Washington stand-off is unnerving investors the world over, particularly in Asia where many nations have massive holdings of US government bonds.

A default or even a downgrade will send the greenback plummeting, savagely cutting the value of those holdings. The unease was reflected in regional markets yesterday with Shanghai leading the rout as shares plunged 2.96 per cent.

Sydney was down 1.58 per cent, Tokyo slipped 0.79 per cent and Hong Kong 0.68 per cent. In Singapore, the Straits Times Index edged down 0.36 per cent.

On Wall Street, the Dow Jones Industrial Average opened 106.37 points, or 0.84 per cent, lower.

The relatively muted falls in Singapore and Hong Kong likely suggest investors have already factored in the default risk or believe an 11th hour compromise will be found.

But some analysts said it was premature to tell if markets can remain sanguine in the days ahead.

‘There’s an old saying that things don’t matter until the day they matter; we’re getting close to the day when it will matter,’ Mr Quincy Krosby, market strategist at Prudential Financial in Newark, told Reuters.

A more telling indicator of the concern could be seen in the commodity and currency markets. Gold surged to a record high above US$1,620 an ounce in Asia trading, while the US dollar crashed to a record low of $1.2071 to the Singapore dollar and 78.13 Japanese yen. But the redeeming grace is that there was none of the panic selling that US politicians feared when talks to raise the debt ceiling broke down over the weekend.

‘Traders view all these wrangling in Washington as pure politics. No doubt, a compromise will be reached eventually,’ said Mr Loh Hoon Sun, Phillip Securities’ managing director.

‘But the market has turned very quiet because uncertainties are keeping investors from making fresh purchases.’

The question remains the same as it has been for weeks: Can a deal be struck by Aug 2 to raise the US$14.3 trillion debt ceiling in order to ensure that the US government does not run short of cash to pay all its bills?

In Hong Kong yesterday, US Secretary of State Hillary Clinton, sought to reassure business leaders that an agreement was in sight, despite the intense political wrangling in Washington.

‘I am confident that Congress will do the right thing and secure a deal on the debt ceiling and work with President (Barack) Obama to take steps to improve our long-term fiscal outlook,’ she said.

China is the single biggest foreign holder of US government bonds with US$1.16 trillion as at May. Other major holders include Japan, Taiwan, Singapore, India and South Korea – vast foreign reserves built up after the Asian financial crisis.

A senior official at South Korea’s central bank, who spoke on condition of anonymity because he was not authorised to speak to the news media, said: ‘Those in direct charge of reserves operations must be more nervous than before. But nobody thinks Americans will choose suicide when they have known solutions.’

Mr Xia Bin, an academic adviser to the People’s Bank of China, the mainland’s central bank, agreed: ‘They will definitely reach a compromise. Don’t worry too much about it.’

But given the risks involved from a default it is not surprising that many people are worrying.

The bond market is jittery over the possibility of the US losing its triple A ratings if lawmakers fail to agree on deep long-term spending cuts to try to balance the budget.

A lower credit rating will raise the borrowing costs not only for the US government but also for other countries and companies across the globe which use US government bonds as the benchmark for pricing their own debts.

One key test of investor confidence will come later this week, as the US Treasury aims to sell US$99 billion in new debt, even as the clock ticks on attempts to resolve the impasse over the debt ceiling. Any weakening in demand would flag growing worries about a debt default.

At least the market’s old hands seem immune to the growing jitters.

Mr James Holt, a fund manager with US-based BlackRock Investment Management, told US cable TV channel CNBC: ‘I have seen this movie before (when there was a US debt default 16 years ago during the Clinton administration).

‘The ironic thing is that despite all the doom and gloom, a year later, Americans produced their first budget surplus in decades.’

Source: Straits Times (subscribers only)

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