U.S. crisis: Fearing the worst, world hopes for best

Having been taken hostage, the world is waiting with bated breath for the outcome of today’s vote on a newly modified plan in the hope that a compromise will be reached by the U.S. politicians over raising the country’s $14.3 trillion borrowing limit by August 2. But the world’s also got a nervous eye on the possibility of the current impasse remaining unresolved pushing the U.S. into debt default.

The situation is extremely fluid right now; it’s a go one minute and a no-go another; a lot of ifs out there, said Serge Pepin, head of investments, BMO Investments Inc.

He says the probability of the calamitous U.S. debt default is rather small, but should it come to pass “you will see a run down on the prices, interest rates going up through the yield curve, [and] some losses on the treasury side as well.”

The bond yield curve, which remained steady, even rallied, up until a couple of days ago, has started to back up a bit. “If something does happen [such as debt default] that’s not positive, then you’d see the yield curve back up quite significantly,” he said while denying it is going to be a Greece-type situation.

Failure to find a way to raise the debt ceiling will further impact a fragile U.S. economic recovery, said Pepin but ruled out a repeat of the 2008 scenario.

“Could we end up in a recession-like scenario? Possibly, [but] it will be the case of short term and the [U.S.] administration will do whatever it can to make sure it doesn’t happen.”

Then there are currency implications to consider, too. The growing appetite to diversify away from the U.S. dollar, will likely further strengthen the loonie that rose today as the U.S. lawmakers prepare for a vote on raising the country’s borrowing limit.

Pepin assures that the current flight of loonie will be short lived, even if the outcome of today’s vote is negative. “We don’t believe that there would be a huge run up in the Canadian dollar, should there be the worst case scenario in the U.S.,” said Pepin. “There may be an initial bump up in the Canadian dollar, but I don’t think it’s going to be lasting, because [that will] impede economic growth, Canada is so dependent on this [as] we are a resource-based economy and we depend a lot of commodities.”

As a default refuge option in turbulent times, gold could gain significantly and “pop through the $2,000 barrier” should the debt debate comes to naught. The correlation between gold and loonie is relatively low as opposed to the one between the loonie and oil prices, said Pepin. “I think oil prices will more than likely soften quite a bit on fears that the demand for oil is not going to be there, [and] that’s going to have an impact on the Canadian dollar.”

Investors who are frustrated and have suffered some wealth erosion should stick to a well diversified portfolio, he said. “[Those in a well diversified portfolio] should be able to navigate through [the current crisis]; you have a cash cushion, any diversified portfolio should have liquidity up to a certain proportion.”

With barely six days left for the U.S. political leaders to reach a deal to raise the limit on U.S. borrowing, global investors and financial industry are bracing for the hitherto unthinkable possibility that the U.S. will not avoid the debt default.

For now all hopes are pinned on the outcome of the crunch House of Representatives vote, albeit with a White House veto threat, due later today.