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WEEK IN FOCUS: 01/08/11 - 05/08/11

As an August 2nd deadline to raise the US debt ceiling approaches, Washington’s indecision on the issue continues to jolt the confidence of the public and markets alike. The United States much prized ‘AAA’ sovereign rating may be at stake if policymakers fail to raise the debt-limit and at the same time provide a realistic approach to tackle country’s swelling public-deficit. However, even if President Obama signs on such an agreement, the sovereign rating of the country may not be secured, as the on-going saga could have significantly diminished the “credibility” of the US government to meet its debt obligations in the eyes of rating agencies and investors – a debate which is likely to gather pace in the near future. It is worth noting that after market close on Friday, Moody’s said that the US’s AAA credit-rating is likely to be affirmed, with a negative outlook. However, default on a Treasury debt obligation would lead to a downgrade, even if the default is swiftly cured.

Adding to the woes was the release of a disappointing second quarter advanced GDP data from the States last Friday, which prompted fears of the world’s biggest economy going back into recession, which in turn may spoil any hopes of a global economic recovery. This also raised the possibility of the Fed opting for another round of “Quantitative Easing (QE)”, and to continue with its policy of “monetising” debt. However, Fed’s Bullard, late on Friday, was quick to point out that the Fed cannot write cheques for the Treasury Department if the government's account runs out of money. Despite that, the Fed may have no alternative but to act if the debt-ceiling debate escalates, resulting in a hike in interest rates, or if the country’s inflation drops significantly owing to persistently weaker growth, together with dissipation of temporary factors supporting inflation.

Elsewhere, in Europe, the turmoil related to Greece’s debt appears to have settled down for the time being. However, major rating agencies, including S&P, Moody’s and Fitch, have placed the country’s sovereign rating on selective default till the government accomplishes a voluntary bond swap of government bonds by longer maturity paper. The contagion fear within the Eurozone, on the other hand, is far from over, with a high level of Italian public-debt being a cause of concern, and as Moody’s placed Spain’s sovereign rating on review for a potential downgrade last week. Market participants will watch carefully results in this week’s Spanish bond auctions giving the relative weakness seen in recent BTP supply and with Spanish and Italian 10yr bond yields continuing to hover around the physiological 6% level.

Looking at the economic calendar, one of main attractions this will be the release of the Nonfarm Payrolls report from the US. It is worth noting that the previous two NFP releases disappointed market expectations, and lacklustre GDP data from the US together with apprehension about an on-going debt ceiling debate may have a negative impact on Friday’s release. We also have a slew of economic data from the US in the form of personal income/spending, PCE report and ADP employment change, among many others. Elsewhere, the ECB is due to announce its August rate-decision on Thursday, where it is expected that the central bank will leave the rate unchanged at 1.50%, partly due to a decline in the Eurozone inflation expectations. Focus will shift onto the ECB’s press-conference, where markets will search for clues regarding future rate path, the central bank’s views on creating a Eurozone fiscal union, together with its take on Eurozone debt concerns. On the same day, the BoE will announce its rate-decision and asset purchase target, where the consensus is for no change at 0.50% and GBP 200bln respectively, primarily on the back of a weaker economic growth in the UK. In fixed income, about EUR 22.5bln worth of supply is due in the market from Eurozone countries including Spain, Portugal and Belgium. We also have 3-, 10-, and 30-year quarterly Note refunding announcement from the US, and it will be interesting to see if the Treasury opts for any change in volume due to the debt-ceiling debate in the US.

**Note: For the latest developments with regards to the US debt ceiling please refer to RANsquawk’s Daily European Opening News Report.