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Fate of US markets rests on Moody's

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2023-10-04

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It's not an overstatement to say that the fate of US financial markets, especially bonds and equities, lies squarely in the hands of credit rating group Moody's, which remains the only one of the big three rating groups with a AAA rating for America's credit standing.

This comes after unprecedented chaos on Tuesday that saw the Republican Speaker of the House of Representatives ousted by his own party.

It was the first time in US political history that a Speaker of the House has been voted out in this fashion, which is remarkable considering the Speaker is in line to become president if the two above them (or her) die or become incapable of remaining in office.

Markets are no longer concerned about what the Fed might do and raise rates at its two-day meeting starting at the end of October. Instead, there is growing concern that America might be plunged into a political and financial crisis it has never experienced before, potentially leading to the loss of the final AAA rating on the country's national debt (totaling $US33 trillion or more).

The Speaker's removal came after continued instability in Washington following a last-minute 45-day funding deal with the Democrats over the weekend, which kept the US government and all its arms open, including defense. This instability culminated on Tuesday when hard-right Republican members of the House of Representatives organised the defeat of their man, Kevin McCarthy, who had been in office only since January.

McCarthy lost 216 to 210, leaving the Republicans leaderless, which adds to uncertainty about government funding and forces already worried investors to sell more US Treasuries, driving American bond yields to 5% and beyond for the key 10-year security.

McCarthy has ruled out making another run for the Speakership.

The Speaker's removal now pits a small group of hard-right Trump supporters against the rest of their party, the Democrat-controlled Senate, and the White House, ending hopes for a more sustainable funding deal in 42 days (after the last-minute deal over the weekend extended funding for the US government by 45 days).

With downgrades from S&P Global (in 2011) and Fitch (in August of this year), America could lose its final AAA rating from Moody's if the Republicans opt for more instability because Moody's has warned it would lower that rating if the funding crisis became protracted.

Moody's downgrade could cause yields on Treasury bonds to spike even higher, underscoring the increased risks associated with holding US debt. This would increase the cost of borrowing money since banks and other lenders often base interest rates on US bond yields.

Last week, Moody's warned that a government shutdown could prompt it to downgrade US debt.

"While government debt service payments would not be impacted and a short-lived shutdown would be unlikely to disrupt the economy, it would underscore the weakness of US institutional and governance strength relative to other AAA-rated sovereigns that we have highlighted in recent years," Moody's wrote.

When Moody's made that statement, the prospect of a shutdown was far higher than Speaker McCarthy being ousted.

US analysts say that just because the government shutdown didn't happen doesn't mean Moody's sees the crisis as having been averted; if anything, the crisis has deepened.

There's a new funding deal to be done by mid-November, around the 14th or 15th, and with the Republicans in the House leaderless but dominated by a small group who don't care about closing down all parts of the government, including the Defense Department, there's no interest in dealing with the Democrats. Thus, a new funding crisis is looming.

For global investors, the outlook is confusing. Should they buy US treasuries because of the security of the US dollar? The dollar's sharp rise in recent days is due to worried investors buying it, but they are selling Treasuries at the same time, creating a confusing situation.

The strong greenback is capping gold and silver prices and pushing other currencies like the yen and the Aussie dollar lower.

Gold prices have declined by more than 2.8% in the past week, and the year-to-date gain has been reduced to less than half a percent.

AAA-rated Australian government debt should appear favorable compared to the US, as should debt from other AAA economies such as Singapore, Germany, and Sweden.

Canada is also AAA-rated, but it's next door to the US and could suffer collateral damage if a new funding crisis and downgrade erupt.

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