Palm | Kelapa Sawit

By Michael S. Arnold

--Asian markets will open in uncharted territory Monday after S&P downgrades U.S. credit

--Asian stocks likely to fall Monday, currencies likely to rise

--In medium term, Asian assets may look more attractive relative to West

--Impact on Asian interest rates more nuanced

SINGAPORE(MarketWatch) -- Asian markets will be the first on Monday to confront a brave new world - one in which the U.S. government does not have the full faith and confidence of the major ratings agencies.

This could make Asian assets look more attractive relative to those of the West, though the immediate fall-out could well be a flight from risk that sends stock markets plunging and bond yields rising around the globe.

In particular, emerging markets could face greater scrutiny from institutions and investors with a renewed awareness of danger.

The U.S. downgrade "is going to be a seismic event," said Ed Rogers, chief executive officer of Rogers Investment Advisors, the Japan advisory firm of New York-based investment firm Wolver Hill Asset Management. Beyond the initial downdraft in stock markets, "the most impact will likely be felt in the currency markets: The dollar is going to continue to get pummeled."

Markets will be on intervention watch Monday, especially after efforts in Tokyo and other Asian capitals last week to stem the upward pressure on their local currencies.

Central banks, from G-7 nations to emerging markets, "will be watching market developments tomorrow with a lot of ammunition, be it buying the (U.S.) dollar or bonds," said Song Seng Wun, executive director of CIMB-Research.

China may raise the value of the yuan in its daily fixing, perhaps to a new all-time high against the dollar. One Shanghai-based Asian bank trader said the People's Bank of China may set a fixing in the 6.4350-6.4400 range, from Friday's 6.4451.

That could be an important benchmark for Asian FX in general, as authorities throughout the region, fearful that rapid appreciation of their own currencies will erode their export competitiveness, keep a close eye on the yuan.

U.S. Treasurys are likely to be sold in a knee-jerk reaction when trading opens in Tokyo at 0000 GMT, even though Asian central banks and other funds currently have few alternatives while the Eurozone is struggling with its own sovereign debt trouble.

Takumi Shibata, chief operating officer of Nomura Holdings Inc., Japan's largest brokerage, told Dow Jones that Monday's market reaction could be less dramatic than anticipated.

"Most investors will stay on the sidelines until their convictions come back to them" and they're able to confirm a trend, he said. "This can happen naturally with or without governments' contributions, but not tomorrow."

In Hong Kong, where the Hang Seng Index has been in correction mode since April, analysts say a 3%-4% selloff Monday wouldn't be surprising.

Longer-term, the S&P development could prove to be positive for Indian and other emerging-market equities, said Mohit Mirchandani, head of portfolio management services at Religare Mutual Fund.

"In times of risk aversion, money would flow out of emerging markets into U.S. Treasurys, but that safe haven is not so safe anymore and there is no other asset class that can replace it immediately," he said.

Traders expect further widening in Asia for credit default swaps, a sort of insurance on sovereign and corporate debt whose daily price fluctuations represent a continual reassessment of risk.

"The cost of borrowing for all financial institutions will be higher because of a loss of confidence on sovereign debt," one trader at a major European bank in Hong Kong said.

The most nuanced impact Monday could be on Asian credit markets.

"Some people might think this could provoke a flight to quality into Asian sovereign assets, but I think the more likely scenario is that people stay nervous about everything," said Guy Stear, head of Asia research at Societe Generale.

A repricing of U.S. risk would tend to drive up interest rates everywhere but the downgrade could also become a significant headwind for the U.S. economy and slow the global recovery, dragging interest rates downward.

"From an interest rate perspective, the weak economy effect (rather than the weak credit effect) is dominating the direction of U.S. rates (pushing them lower) and the short-term impact of the U.S. on Asian rates thus seems likely to remain downward as well," DBS wrote in a research note.

"In practice, however, if Treasuries fall into a lower tranche of fund manager portfolios, this leaves less room for other countries' bonds, and so on down the line. Upward pressure on yields of other-country bonds could result," DBS said. "Whether theory or practice obtains here, we'll just have to wait and see."