S&P cut on U.S. debt to result in turbulent markets: analysts

BANGALORE Mon Aug 8, 2011 10:36am EDT

A trader works on the floor of the New York Stock Exchange, August 2, 2011. REUTERS/Brendan McDermid

A trader works on the floor of the New York Stock Exchange, August 2, 2011.

Credit: Reuters/Brendan McDermid

BANGALORE (Reuters) - The Standard & Poor's downgrade of the U.S. sovereign debt could lead to turbulent equity markets in the short term and dull investors' appetite for risks, according to most Wall Street analysts.

However, they see little long-term impact on U.S. equity markets from the downgrade and said a rebound in equities is well underway as macroeconomic data continues to stabilize.

The downgrade of the country's AAA credit rating on Friday is expected to have a spill-over effect on the financial system -- from mortgages to banks to markets -- that rely on U.S. Treasuries for collateral.

"We believe the medium to long-term effects of the US sovereign downgrade are minimal, even as the short impact (next two weeks) could be turbulent," J.P. Morgan Securities' chief equity strategist Thomas Lee wrote in a note.

With all eyes really on the problems in Europe, the S&P downgrade will cause "little turbulence," said Lee, while noting that investors view the S&P cut as a "sideshow" and as further reason to reduce risk.

Separately, Barclays Capital's U.S. equity strategist Barry Knapp said investor sentiment is reaching extreme levels of bearishness and that the crisis in Europe and macroeconomic outlook were more important to investor psychology than the downgrade.

"The downgrade may actually help spur the Europeans to catch up to the markets. If that proves to be the case, the stabilization of the macroeconomic outlook should spark a rally in equities," Knapp wrote in a note.

Historically, equity markets have generally rallied even after sovereign downgrades by rating agencies, JP Morgan's Lee said.

"Corporates have gained significant credibility against sovereigns, and given their impressive gains (share of GDP) argue for lower equity risk premia and thus, we expect equities to regain traction following a return of visibility on sovereign debt markets," Lee wrote in a note to clients.

In addition, with the July job report showing reasonable momentum, the U.S. economy is still on its way to recovery, analyst Lee said.

IMPACT ON BANKS, DOLLAR

The S&P downgrade should not "be a meaningful issue" for U.S. banks, and will have no impact on banks' capital levels, analysts at Robert W. Baird said in a separate report.

The Federal Reserve and U.S. FDIC has said the sovereign debt exposure has a zero risk weighting for regulatory capital calculations.

While the downgrade puts a dent in the US dollar as a reserve currency, central banks of emerging markets are unlikely to be in a rush to unwind their dollar holdings, said BofA Merrill.

Standard Chartered analysts, however, expect the downgrade to trigger a broad-based selling of the US dollar against G10 and emerging market currencies.

G10 refers to countries that have agreed to the General Arrangements to Borrow to make resources available to the International Monetary Fund. The G10 includes countries such as Canada, France, United Kingdom, Germany and Sweden.

(Reporting by Rachel Chitra in Bangalore; Editing by Joyjeet Das)