Sovereign debt seen as biggest threat

NEW YORK (Reuters) - The specter of sovereign default looms large for world economies in coming years, and the debt tsunami that has engulfed countries from the United States to Dubai poses a threat to recovery, top money managers at the Reuters Investment Summit said this week.

Concerns about potential government insolvencies took the spotlight after a debt crisis erupted in Dubai last month and after ratings agencies this week cut Spain’s credit outlook to negative and downgraded Greece’s credit rating.

Sovereign concern, “for the next at least two to three years, will definitely be a risk factor in the marketplace that investors will be paying attention to,” Jonathan Xiong, a director and senior portfolio manager at Mellon Capital Management, said at the Summit in New York.

Major world economies responded to last year’s steep downturns spawned by the financial crisis with big stimulus packages and by underwriting private debt obligations, causing deficits to balloon. While this helped stave off an even worse recession, high debt has the potential to strain economic resources in coming years.

The United States and United Kingdom are not immune from this threat. Moody’s earlier this week suggested that the countries’ triple-A ratings could face downgrades in coming years.

The United States and UK are “the two most grievous examples of irrational exuberance from the standpoint of a national economy,” said Bill Gross, who runs Pacific Investment Management Co., the world’s biggest bond fund.

The news about Dubai and Greece, he said, speaks “to the necessity to get our shop in order.”

The fiscal challenges facing many economies had been largely put on the back burner in recent months as investors were preoccupied with the credit crunch and deep economic slowdowns around the world.

Now that the worst of the crisis seems past and asset prices have rebounded, investors will likely focus on long-term fiscal imbalances in many countries. An auction of $13 billion in 30-year U.S. Treasury bonds on Thursday was met with poor demand, suggesting such concern has moved to the fore. U.S. bond yields, which move inversely to price, have risen sharply in the last week.

Todd Harrison, chief executive of Minyanville Media, said sovereign defaults and state bankruptcies are key factors that could trigger the next stage of what he calls an ongoing crisis.

Unlike previous crises, the countries posing the biggest risk are in the developed world.

Measures of sovereign risk jumped this week on the heels of the ratings announcements on Greece and Spain. Credit Derivatives Research said on Thursday that its government risk index, which tracks seven major economies, showed credit default swaps of all economies, save Japan, trade with “greater risk now than a week ago.”

The worst performer on the week was the UK, whose sovereign risk jumped by almost 20 percent. The United States held up this week, but its credit default sways “already traded over 70 percent higher than recent lows, among the worst-performing major sovereign CDS,” the firm said.

Still, near-term downgrades on the United States and UK seem unlikely. Analysts at Moody’s Investors Service on Friday said a worst-case scenario suggests a cut by 2013 for either country.

US DOLLAR AT RISK?

The euro has been weakening of late. It was last at $1.4653, well below a nearly 16-month high above $1.5140 set in late November, according to Reuters data.

Despite the dollar’s rebound, Mellon Capital’s Xiong said the credit quality of U.S. government debt has worsened recently relative to other major economies, and the large debt burden of the United States will weigh over the longer term.

The U.S. government posted a record $1.4 trillion deficit in the 2009 fiscal year ended in September as tax revenues plunged and spending soared. The deficit in the first two months of the new fiscal year stands at $296.7 billion.

In the UK, finance minister Alistair Darling revised his borrowing forecast for this year up to a record 177.6 billion pounds ($290 billion) or 12.6 percent of gross domestic product, despite warnings by ratings agencies.

While a near-term rebound is likely, the dollar will ultimately continue to decline because of the fundamental problems in the U.S. economy, said investor Jim Rogers, pointing to the 90 percent drop in the value of the British pound in the 20th century.

“No country in history that has gotten itself into this situation has gotten itself out without a crisis.”

(For summit blog: blogs.reuters.com/summits/)