Another rough day and night on the world’s markets, and not even a rally in the US late in the day can change the fact that the loss of confidence in major economies continues unabated.

Markets are starting to question the ratings and credit worthiness of a growing number of countries, with this report in the Financial Times overnight suggesting that the huge Japanese institutional funds management sector is becoming wary of buying euro bonds or other securities once thought safe.

And this morning, Moody’s ratings group warned for the second time in four months that America’s Aaa bond rating will come under pressure if cuts are not made to budget deficits and debt.

Moody’s comments echo those made last month by Fed chairman Ben Bernanke, who said:

“Our nation should soon put in place a credible plan for reducing deficits to sustainable levels over time. Doing so earlier rather than later will not only help maintain the US government’s credibility in financial markets, thereby holding down interest costs … failing to put the nation’s finances on a sustainable long-run trajectory would ultimately do great damage to our economy.”

The comments from Moody’s come as the Obama Administration is preparing a new spending Bill, rumoured to total $US200 billion. The Bill contains help for small business, more unemployment support and funds for the states to prevent hundreds of thousands of teachers and support staff being sacked later this year when the new US school year starts and stricken state and local governments are forced to cut to reduce spending.

The suggested Bill has alarmed Democrats and Republicans alike and may not get through Congress, such is the growing political concern about the US deficit. If that happens, American unemployment will surge in the last quarter, putting further downward pressure on an economy already forecast to be slowing.

Moody’s issued a similar warning in February, but this time, as then, it retained the US rating at the highest level with a positive outlook because of a “high degree of economic and institutional strength”.

But it pointed out that the US government’s finances have been “substantially worsened by the credit crisis, recession, and government spending to address these shocks. The ratios of general government debt to GDP and to revenue are deteriorating sharply, and after the crisis they are likely to be higher than the ratios of other Aaa-rated countries.”

Moody’s also said last December that public finances in the US and the UK were worsening in the wake of the global financial crisis and the sovereigns may “test the Aaa boundaries”. It said the US and UK have “resilient” Aaa ratings, as opposed to the “resistant” top ratings of Canada, Germany and France.

In the FT article, it reported that Japanese investors (who control hundreds of billions of dollars of funds) are losing faith in euro bonds.

It quoted an survey of Japanese funds managers by Barclays investment bank, which found that at the start of this year, almost 80% of the “survey’s respondents preferred euro debt to dollar debt, but that proportion is now below 30 per cent … Japanese investors are not just worried about debt issued by the peripheral economies of Portugal, Italy, Ireland and Greece; they seem pretty uneasy about German bonds too.”

This helps explain why there’s a rise in fear of risk and increased volatility in markets. Nothing the Europeans can do or say can ease those fears. It is driving changing relativities between investors and sectors. It’s overlaid by fears about the health of the Chinese recovery, the return of fears about the health of banks, especially in Europe, and the ongoing fear that slow growth in Europe will turn into recession because of the austerity cuts. China’s health is seen as threatening booming (relatively and actual) Asian economies, including Australia.

That’s why the Aussie dollar fell below 82 US cents yesterday and last night, and then swung back up towards 83c in a night of big (but at the moment normal) changes. Another factor leading to the high volatility in the Aussie dollar is that the $A/$US pair is the fourth most traded currency pair globally (while the Aussie is the sixth most traded currency by itself). That the Aussie is such a liquid and easy-to-trade currency makes it an ideal plaything for investors of all sizes. Local commentators avoid mentioning that fact when commenting on markets.

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Peter Fray
Peter Fray
Editor-in-chief of Crikey
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