North American markets plunged in the first full day of trading following the credit rating downgrade of the United States, as investors looked for safer bets at a time of extreme financial uncertainty.
At the end of trading, the Dow Jones industrial average,dropped 634.76 points, or 5.5 per cent, to 10,809.85; the S&P 500 fell 79.92 points, or 6.66 per cent, to 1,119.46; and the S&P/TSX Composite Index slid 491.21 points, or 4.04 per cent, to 11,670. 96.
The significant declines, which follow what was already the most brutal week for global stock prices since the depths of the 2008 recession, indicate severe investor concern about the potential for a so-called "double-dip" recession. That concern was punctuated on Friday when credit rating agency S&P announced a downgrade of the U.S. rating from triple-A to double-A-plus – the first time in modern history the U.S. has experienced such a downgrade.
The S&P decision unleashed an angry war of words between the agency and the White House, forcing both sides to take to the airwaves to defend their positions. Nonetheless, the reaction from investors seems to indicate the broader concern is with the global economic situation, rather than what is at least partially a symbolic ratings downgrade.
In an attempt to counter criticism, S&P held a teleconference Monday to further explain its decision. The agency sought to frame the downgrade as primarily related to what it sees as a polarized political environment and how it affects Washington's ability to make fiscal decisions. David Beers, S&P's global head of sovereign ratings, specifically mentioned "the extraordinary difficulty people are having in finding common ground," when it comes to U.S. fiscal policy. Indeed, S&P's negative outlook over the next six to 24 months means the firm is not optimistic that the congressional committee charged with suggesting budget cuts will ultimately improve Washington's situation.
According to S&P, in previous cases where a nation has lost its triple-A rating, the shortest time it took to regain that rating was nine years, and the longest was 18 years (although the firm cautioned that each case is unique).
However in terms of risk, the rating change is fairly symbolic. S&P has never seen an AA-plus nation default on its debt. As John Chambers, chairman of Standard & Poor's sovereign debt committee, put it: "It's like going from indigo to navy blue."
In fact, on a day when most global equity markets saw steep declines, U.S. treasuries actually rose – a sign that investors are keen on safe bets during a time of uncertainty.
"Despite losing its mint rating, the U.S. is extremely unlikely to default, given its enormous wealth and potential to raise tax revenue," said Sherry Cooper of BMO Capital Markets. "The deep, liquid Treasury pool will still be the one investors dive into when the financial climate gets sticky."
Brazilian President Dilma Rousseff took time in her speech at a signing ceremony Monday with Prime Minister Stephen Harper to criticize the downgrading of the United States' credit rating.
"We do not agree with the rush to valuation, I would even say incorrect evaluation by Standard and Poors, which reduced the credit rating of the U.S.," Ms. Rousseff said.
Mr. Harper, who is in Brazil to strengthen trade ties with the emerging global power, did not reference the downgrade, but said their discussion included the economic situation.
Around the globe, equity markets took a beating. Asian markets, including those in China, Australia, Hong Kong and Japan, all ended Monday trading down. Tokyo's Nikkei average dropped more than 2 per cent on the day, while the Shanghai Composite dropped almost 4 per cent.
European markets were mixed in early Monday trading. After a brief morning rally, fears of a so-called "double-dip" recession sent the FTSE 100 skidding and it closed down 3.4 per cent in London.
Markets had been up more than 2 per cent both in Milan and Madrid, after the European Central Bank promised to help support Italy and Spain's uncertain debt situation through a bond-buying program. Bloomberg reported early Monday that the ECB had begun buying Italian and Spanish government bonds, citing people familiar with the transactions.
In an indication of just how perilous the global financial situation has become, finance ministers and central bankers from the Group of 20 nations issued a joint statement Monday promising to "remain in close contact throughout the coming weeks and co-operate as appropriate, ready to take action to ensure financial stability and liquidity in financial markets."
Safety appeared to be the primary concern among investors around the world Monday. The price of gold – long considered an indicator of investor nervousness – broke through another barrier Monday, jumping above $1,700 (U.S.) an ounce and setting another record.
The U.S. dollar weakened slightly against most major currencies, including the euro and the yen. However, one of the sharpest drops came against the Swiss franc, as the greenback weakened to a new low of about 76.10 centimes early Monday in London (there are 100 centimes in a Franc). Like gold, the Swiss franc is considered a sort of safe-haven for investors during periods of uncertainty.
The S&P downgrade of the U.S. credit rating, announced Friday, came as a bitterly fitting end to one of the worst weeks for global markets in almost three years. According to the MSCI All-Country World Index, roughly $2.5-trillion disappeared from the value of stocks around the world during the week.
Much of the significance of the downgrade may be months down the road, although it's difficult to gauge exactly what the consequences will be, because the move is unprecedented. Indeed, some financial instruments have taken it as a given that the U.S. borrowing rating is and always will be essentially risk-free. With the S&P's move, investors will now pay very close attention to the other two major credit-rating agencies, Moody's and Fitch, to see if either follow (even though both recently reaffirmed their triple-A ratings for the U.S.).
The Federal Reserve's Open Market Committee, due to meet Tuesday, will also be the subject of intense scrutiny.
"S&P's decision certainly makes this week's FOMC meeting much more interesting with respect to the Fed's reaction to the downgrade, and whether or not they once again downgrade their outlook for the U.S. economy," CMC Markets analyst Michael Hewson said in a note.
The FOMC will likely leave the Fed Funds Target rate at 0.25 per cent, according to the median estimate of 100 economists surveyed by Bloomberg.
With files from Globe and Mail reporter Steven Chase in Brasilia and Associated Press