How the U.S. Dollar Will React to a Government Default

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 |  Includes: FXA, FXC, FXE, FXF, GLD, UDN, UUP
by: Andrei Tratseuski
Broad weakness in the United States Dollar is prompting its counterparts to rally at an accelerated rate. The Swiss Franc, the New Zealand Dollar, and the Canadian Dollar all are making yearly highs against the greenback. Market participants continue to weigh in on a potential default from the United States. The United States credit rating, which remained at triple-A since 1917, is in jeopardy of being downgraded if the United States government does not extend the debt ceiling by August 2. A lack of an extension of the debt ceiling will force the United States government to default on its obligations, an action the United States did only twice:
  1. Failing to repay debt to the French after the Revolutionary War, and
  2. in 1979, when the United States did not make a timely manner payment to creditors.
What if the US government defaults?
The last time the United States government defaulted on its obligations, the U.S. Dollar rose in the process after a timid pullback (see chart). We believe the same will take place if the United States defaults on August 2. Despite the fact that the dollar is currently losing value against other major counterparts, a default will prompt a risk aversion rally. In the process, funds will flow into United States Treasuries, prompting the dollar to the upside. Treasuries are still considered a risk-free asset, despite a default. So, investors fleeing to safety will seek to put their funds into Treasuries.



However, dollar gains are unlikely to come against the commodity currencies, the Swiss Franc, and gold. Currently, investors are protecting their assets by investing in economies backed by raw materials, especially the Canadian, Australian, and New Zealand economies. The Swiss Franc once again established itself as a core safe haven currency and funds will continue to flow to this best performing developed nation if the US default manifests. Finally, gold will inch higher if the US debt ceiling is not passed as investors continue to use precious metals as safe havens. Without a question, if the United States defaults on its debt obligations, the credit rating of the United States will be downgraded.



Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.