A breach of the U.S. debt ceiling may affect the dollar more than Treasuries because international holders of the debt may view the risk of permanent losses greater than domestic investors, according to Citigroup Inc.
“The foreign exchange reaction to a debt ceiling breach would be sharper and probably more permanent,” Steven Englander, the head of Group of 10 foreign-exchange strategy in New York at Citigroup, wrote in a note today. “It would legitimately tax foreign investor patience and lead to further dollar dumping whenever the opportunity arises.”
Foreign investors who don’t hedge against swings in the value of currencies with strategies such as options can’t be guaranteed that prices will recover if volatility climbs as lawmakers fail to reach agreement on extending the legal amount the U.S. can borrow, Englander said. Congress has until Aug. 2 to find a way to avoid default after the amount the government can borrow was reached May 16.
The House of Representatives today will vote on increasing the $14.3 trillion threshold by $2.4 trillion. Senate Republican leader Mitch McConnell of Kentucky has said his party wants “significant” cuts in spending and no tax increases as a condition for raising the limit.
“If it’s a U.S.-based sovereign crisis, the dollar will ultimately lose value,” said Greg Anderson, a senior currency strategist at Citigroup. “If there’s a parallel crisis in Europe, then probably the better alternative currencies are those that are not fiscally challenged: Canada, Australia, New Zealand, Norway, Sweden. They didn’t have the same fiscal problems.”
The U.S. dollar fell 7.2 percent in the past year against the Canadian currency, 17 percent versus New Zealand’s dollar and 21 percent compared with the Australian dollar
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