Sinking ships

Julian Harris
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S&P’s downgrade of US debt outlook rocks global markets

US told it must slash budget deficit or lose AAA-rating

Eurozone yields soar as sovereign debt crisis intensifies

SOVEREIGN debt fears gripped markets on both sides of the Atlantic yesterday, after the US’s triple-A debt rating was put on a negative outlook by ratings agency Standard & Poor’s and investors moved to price in a Greek restructuring as early as June.

Greece’s deteriorating public finances have sparked worries that a restructuring could set off a chain reaction of bank collapses and threaten the viability of the single currency.

And in Washington, S&P’s shock warning was provoked by the “material risk that US policymakers might not reach an agreement” over how to solve its colossal government deficit.

The US government’s debt stands at $14.27 trillion (£8.8 trillion) while the annual deficit is around $1.4 trillion.

Debt is predicted to reach 84 per cent of GDP by 2013, S&P announced in its statement yesterday.

“We see the path to agreement as challenging because the gap between the parties remains wide,” S&P said, in reference to ongoing clashes between Democrat and Republican proposals for deficit reduction.

The Democrat-controlled Senate is expected to reject the Republicans’ latest proposal to slash $5.8 trillion of federal spending in the next 10 years.

Last week President Obama attacked the proposals, which would involve reforms to America’s large state-funded healthcare programme, Medicare.

Even if a settlement is reached, “implementation could take time,” S&P warned. And future politicians “could decide to at least partially reverse fiscal consolidation”, it added.

Obama’s government swiftly hit back at the accusation.“We believe S&P’s negative outlook underestimates the ability of America’s leaders to come together to address the difficult fiscal challenges facing the nation,” said Mary Miller, a senior Treasury official.

Shorter-dated US Treasury debt prices rose as investors scrambled for the lowest-risk investments. But even though 30-year bonds reversed early gains to trade negative in price, the 10-year yield remained comfortably under 3.5 per cent and 10-year prices posted modest gains in the afternoon.

In Europe, reports that Germany is not expecting Greece to make it through the summer without defaulting on its debt caused turmoil in debt markets.

The yield on Greek debt reached unprecedented levels, with two-year rates soaring over 20 per cent.

The cost of insuring Athens’ paper has also risen to eye-watering levels: it now costs more than €1.15m (£1m) to insure €10m of five-year Greek debt with a five-year credit default swap.

The Eurozone does not have a plan for how to handle a default, with fears for the single currency sending yields up even in Spain, which analysts had declared to be immune to contagion.

Madrid saw demand drop, selling €4.7bn of 12- and 18-month bonds. The average yield of 2.77 per cent was a substantial increase on the 2.13 per cent at its last equivalent sale.
Analysts expect the resulting haircuts on Athens’ debt to set off another financial crisis in Greece, where domestic banks have heavy exposure to the sovereign.

International banks will also suffer: Barclays has €4.6bn of exposure to Greek debt and Societe Generale has €4bn of exposure.

Meanwhile, a rush to “safe havens” saw gold rally, touching $1,497.20 an ounce. Brent Crude dropped to a session low of $121, also affected by Sunday’s announcement of a cut in March’s output from Saudi Arabia.