Dollar, Bonds
The dollar weakened and Treasuries declined after the Moody's statement. IntercontinentalExchange Inc.'s Dollar Index, which tracks the greenback against the currencies of six U.S. trading partners, including the euro, yen and pound, slid for a third day, shedding 0.4 percent as of 9:53 a.m. in London.

The 10-year Treasury yield rose three basis points to 2.91 percent, according to Bloomberg Bond Trader prices. The price of the 3.125 percent security due in May 2021 declined 1/4, or $2.50 per $1,000 face amount, to 101 25/32.

The cost of insuring Treasuries rose five basis points to 56.5 basis points, the highest since February 2010, according to CMA prices for credit-default swaps.

The risk of a default is causing concern in Asia. China is the biggest foreign holder of Treasuries and Japan ranks No. 2.

Dagong Global Credit Rating Co., a Chinese company, said today that it was putting its A+ rating for the U.S., the fifth-highest level, on “negative watch,” citing the nation's deteriorating ability to repay debt.

Assessing Risks
China needs to “seriously assess the risks” of its holdings as the U.S. faces a “worrisome” economic outlook, Yu Bin, a senior government researcher, told reporters at a briefing in Beijing today.

The nation hopes the U.S. will adopt “responsible policy to ensure investors' interests,” Chinese Foreign Ministry spokesman Hong Lei said at a separate briefing.

The Aaa ratings of financial institutions directly linked to the U.S. government, including Fannie Mae, Freddie Mac, the Federal Home Loan Banks, and the Federal Farm Credit Banks, were also put on review for cuts, Moody's said. It also placed 7,000 municipal ratings on review for possible downgrade.

“What we're looking for is a raising of the limit. It doesn't matter the process that they get there,” Steven Hess, the senior credit officer at Moody's in New York, said in a telephone interview.

Obama's Exit
Senate Republican Leader Mitch McConnell proposed a “last choice option” on July 12 that effectively would grant Obama power to raise the debt limit in instalments. McConnell's plan would let the president raise the limit in three stages unless Congress disapproves by a two-thirds majority, while Obama would also be required to propose offsetting spending cuts.

The spending reductions would be advisory, and the debt-ceiling increase would occur regardless of whether lawmakers enact the cuts.

Obama “abruptly” walked out of yesterday's White House meeting with legislative leaders on the federal deficit, House Majority Leader Eric Cantor, a Republican from Virginia, told reporters.

“This report underscores the warning I outlined months ago,” House Speaker John Boehner, Republican of Ohio, said in a statement. “If the White House does not take action soon to address our nation's debt crisis by reining in spending, the markets may do it for us.”

“I think it reflects what we all know — that this is a serious time and serious discussions and we can't continue to have people not contribute to solving this problem,” said Senator Patty Murray of Washington, the No. 4 Democratic leader in the chamber.

Reaching a Deal
Standard & Poor's put the U.S. government on notice on April 18 that it risks losing its AAA credit rating unless policy makers agree on a plan by 2013 to reduce budget deficits and the national debt. The firm said at the time that there's a one-in-three chance that the rating might be cut within two years and that its “baseline assumption” is that Congress and the Obama administration will come to terms on a plan to reduce record deficits.

S&P would lower its sovereign top-level AAA ranking to D, the last rung on its scale, if the U.S. can't make its payments because of a failure to raise the debt ceiling, John Chambers, chairman of the sovereign rating committee, said June 30.

The U.S. is among 17 countries, from Australia to Canada to Switzerland, rated Aaa by Moody's. S&P gives 18 countries its top ranking.

It's likely that the debt ceiling will be raised without a credible plan for debt reduction, pushing yields higher for longer-term securities, according to Bank of America Corp.

Debt Trajectory
A debt-ceiling increase before Aug. 2 would lead yields on 30-year Treasury bonds to rise faster than five-year notes, reflecting increased concern that the long-term fiscal situation will worsen, wrote analysts led by Priya Misra, head of U.S. rates strategy in New York at Bank of America Merrill Lynch.

“The rating outlook will be determined by the longer-term debt trajectory,” Hess said yesterday of the Moody's rating.

Treasury Secretary Timothy F. Geithner said he has taken steps to prevent a federal default until Aug. 2, using accounting measures that involve two retirement funds. The U.S. reached its borrowing limit on May 16.

The Moody's announcement is a “timely reminder” that Congress must “move quickly” to avoid default, the Treasury said in a statement.

Government bonds yields are at about the lowest this year. Ten-year yields remain below 3 percent, compared with an average of 7 percent during the past four decades. Two-year U.S. government debt yields 0.37 percent, compared with the low for 2011 of 0.32 percent on June 24.

Temporary-Default Scenario
Demand has been higher than average this week at the Treasury's auctions of three- and 10-year notes this week as investors continue to seek a U.S. refuge from Europe's worsening sovereign-debt crisis.

While yields remain low, investors remain concerned they will increase as the borrowing deadline approaches.

Yields on 10-year notes would rise about 37 basis points if the U.S. government temporarily misses a debt payment while promising to make bondholders whole as soon as the debt limit was raised, according to the average estimate of 45 JPMorgan Chase & Co. clients that were surveyed by the firm. Foreign investors forecast yields would rise 55 basis points.

An increase in Treasury yields of 50 basis points would reduce U.S. economic growth by about 0.4 percentage points, JPMorgan said in a report, citing Fed research and data.

“It certainly underscores the importance of passing the debt ceiling and not putting us in default status, and making sure there's a longer-term fiscal plan to contain spending and the deficit we've been running up over the last few years,” said Anthony Cronin, a trader at primary dealer Societe Generale SA in New York.

Bloomberg News

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