NEW YORK (Reuters) - The U.S. dollar may fall next week on concern the United States may lose its top-notch credit rating with politicians nowhere close to reaching an agreement on lifting the U.S. debt ceiling as an August 2 deadline looms.
Fears of a full-blown euro zone debt crisis have subsided for now after the announcement of a second bailout for Greece and the focus is shifting to Washington where efforts to avoid a U.S. default enter crunch time.
The drawn-out battle has dented risk appetite in recent weeks and led ratings agencies to warn of a potential downgrade. Such a move, some fear, could send interest rates soaring and erode the dollar’s reserve currency status.
Dollar investors have so far been complacent as the U.S. currency rose against the euro and a basket .DXY on Friday. Most investors expect some sort of deal by August 2 to avoid a default, although some fear that failure to reach a major deficit cut plan could lead to a credit ratings cut. That worry is set to grow as time is running out.
“If the markets don’t hear anything going into the weekend, I think the first instinct will be to sell first and ask questions later,” said Boris Schlossberg, director of currency research at GFT in New York.
“There’s much less cooperation amongst the U.S. legislators than there is amongst the Europeans. That kind of dichotomy could begin to hurt the dollar ...”
While efforts to craft a $3 trillion deficit-reduction deal gained traction on Thursday, the White House and Republicans have not broken their impasse over higher taxes, which are opposed by the Republicans, who control the lower house.
The White House initially set a July 22 target for a deal that would leave enough time to get it through the legislative process. But it has backed off that timeframe.
“It’s brinkmanship and no one’s going to blink until they really have to,” said Mark McCormick, currency strategist at Brown Brothers Harriman in New York. “The market would really like to see a big deal, something along the lines of $3 to $4 trillion that really addresses the structural problems of the U.S. economy.”
Standard & Poor’s said on Thursday there is a 50-50 chance the U.S. AAA credit rating could be cut within three months.
“The potential for the U.S. to lose its triple-A rating is definitely there,” said Andrew Busch, global currency and public policy strategist at BMO Capital Markets in Chicago. “That is going to be problematic for the markets, which would cause the market probably to sell the U.S. dollar.”
Analysts expect the dollar to weaken especially against the safe-haven Japanese yen and Swiss franc.
The debt ceiling impasse has also whipsawed 30-year Treasury bonds lately, as the long-dated debt is most vulnerable if the country fails to reduce its deficit.
A downgrade to AA will likely hurt Treasuries, though most fund managers are not thought to be restricted by the government debt’s ratings and thus are unlikely to be forced to sell the debt.
Thomas Higgins, global macro strategist at Standish Mellon Asset management, said that ironically, in the event of a U.S. default, which is highly unlikely, investors may want to be overweight Treasuries in the short term because of the negative implications for economic growth. Standish oversees $80 billion in assets.
The euro last traded down 0.4 percent at $1.4361. The dollar also rose 0.3 percent to 0.8178 Swiss franc, off a record low of 0.8034 set on Monday. It also rebounded from an earlier four-month trough of 78.22 yen to last trade at 78.43 yen.
“The dollar has remained largely unmoved thus far because no one wants to be caught with a short position in the event that Congress starts singing ‘kumbaya’,” said Karl Schamotta, senior market strategist at Western Union Business Solutions. “The markets have already largely discounted a positive outcome.”
Some analysts are skeptical how much the dollar could benefit even if politicians make notable progress on a deal.
Alan Ruskin, global head of G10 currency strategy at Deutsche Bank in New York, said while a rally in the first 24 hours is possible, the dollar could come under renewed pressure as an increase in global risk appetite encourages investors to use the dollar as a funding currency.
Additional reporting by Nick Olivari, Gertrude Chavez-Dreyfuss and Karen Brettell; Editing by James Dalgleish