I doubt anyone has a sure answer on this. Rating agencies will get harassed by US gov't (if they haven't already) if downgrade comes. I think that it will mark the beginning of the end for those who will downgrade US (but I really do not care).
We are to be prepared for the downgrade nonetheless. Let's go over the scenarios if it comes.
1. End of rally for equities I say. It will create an unnecessary weight on equities. Many huge players will be scrambling to find a safe place to hide the funds coming out of AAA securities. Stocks are too vulnerable here for a safe bet. Sell first, ask questions later will be the name of the game. Risk off as soon as downgrade is announced.
2. Dollar takes a one-day hit but then turns around due to risk-off trade. It has to be a pretty huge move for equities to trigger a u-turn in DXY. So I say wait for a climax selling in stocks to develop, but I personally will be watching a test of 73.
3. Due to risk-off trade all risk currencies will get dumped. AUD, CAD, GBP, and EUR will get hit across the board (after initial one-day rally). JPY and CHF will shoot higher, not sure for how long, as SNB and BOJ will be looking to curb the rise somewhat.
4. Gold shoots higher and oil craters.
Gold goes opposite of risk lately, but really has its own bull mind developed. It just wants to rally on any occasion. Could there be a better one than US losing AAA debt rating? Raging bull...
Oil is a simple 100% correlation to SPX. So it will follow down without any hesitation.
Many will doubt my theory of gold and dollar going higher, but it can happen during turbulent financial market times.
UPDATE Aug 1 10:15 am
Wow, is this trade already on???
UPDATE #2, Aug 2 @ 8 pm
Fitch and Moody's (wisely) decided not to play with fire, and affirmed US AAA debt rating. They did warn that outlook is negative and downgrades could still happen, if economy slows down considerably and debt cuts are not enacted soon. This leaves S&P. I bet they are waiting for this market turbulence to stop first, so not to aggravate the issue at hand. They may downgrade US debt, once we have a rally.
UPDATE #3 Aug 5 @ 12:50 am
Now that we are 12.5% off the high on SPX, it will be interesting how the market reacts to a possible downgrade by S&P. It may actually rally, in sell the rumor buy the news effect.
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