Thursday, 28 July 2011

Why a downgrade on US credit rating will not be as harsh as it seem?

A downgrade on US credit rating will probability be embedded in our mind now. Most of the people will think that this will eventually lead to a pro long downfall for US economy. Think twice, this may not be 100% true. A downgrade will normally cause the currency of the country to drop against others, but with US dollar as a reserve, this may not be much of the effect. During April when S&P put US credit outlook on negative, there isn't much effect on US dollar; rather risky assets were sold off as reflected by the US indexes, and because of that pushes up the US dollar.

Next, US market is always the most liquid market in the world. We cannot disregard the fact that the world reserve is still the US dollar. The possible outcome will be a quick sell off of risky assets around the globe after the rating agencies downgrade US credit rating. If risk appetite declines and investors fly toward 'safe haven', the dollar will still be the good place to hide from the risk-off trade.

Risk appetite will be the stake in this game. Most people will think that US dollar is no longer safe. Yes, to a certain extend it is showing sign of cracking. However, if we go back to basic, eventually we will realise that it will be useful one day.


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