Tensions are ratcheted up as US politicians come under pressure to resolve the the government's budget deficit.
Dollar falls as US is put on alert for downgrade
US treasuries and the dollar weakened substantially yesterday after Moody's Investors Service warned that the world's biggest economy was on course to lose its top credit rating if Congress failed to resolve an impasse over the government's US$14.29 trillion (Dh52.48tn) debt limit.
Stakes were further ratcheted up after Barack Obama, the US president, set a deadline of today for politicians to decide how to achieve a breakthrough in the debt standoff.
"A US default would be a major shock to the financial system of the globe," said Mahdi Mattar, the head of research and chief economist at CAPM Investment in Abu Dhabi. "If this was to happen, the perception of the risk-free asset of US treasuries would change."
Fresh debt concerns in the euro zone also buffeted the euro after Fitch, another ratings agency, downgraded Greece. Both the dollar and the euro fell to record lows against the Swiss franc as investors turned to the refuge currency. Gold also advanced to new highs.
The 10-year treasury yield added two basis points to 2.90 per cent in New York with the dollar index dropping 0.2 per cent.
The fiscal challenge facing the US economy has had an impact on the Gulf. The region is home to large US treasury holdings but low interest rates this year have made it less attractive for investors to buy more US government debt.
Dollar weakness also has an effect through the dirham's currency peg to the greenback. A lower dollar erodes the purchasing power of the dirham, making it more expensive to buy foreign goods and risks raising inflation.
Talks aimed at breaking the political stalemate about the US deficit ended acrimoniously late on Wednesday.
The deadlock prompted Mr Obama to tell politicians they had until today to decide whether they could strike a deal to reduce the deficit or settle for a way to raise the debt ceiling, two Democratic officials told Bloomberg News.
A resolution is needed before August 2 to avoid a potential default on the country's debt.
In a warning of what could happen if no breakthrough was achieved, Moody's on Wednesday said there was a growing possibility the statutory US debt limit would not be raised in time, leading to a default on the country's treasury debt obligations.
It said it would review the government's "triple-A" bond rating for the first time since 1995, adding it considered the probability of a default on interest payments to be low.
Moody's has never given the US government anything below its top rating since it began evaluating the country's debt in 1917.
But the government reached its borrowing limit in May as the country built up a debt hangover from the global financial crisis.
In testimony before the House financial services committee, Ben Bernanke, the US Federal Reserve chairman, had previously said a crisis similar to 2008 would be "certainly conceivable".
It would have a "very adverse effect very quickly on the recovery", he added.
Politicians have few options for resolving the situation speedily. Mr Obama said he would veto any plan that did not raise the debt ceiling until after the elections next year. Republicans want at least $2tn in spending cuts without any tax increases.