Most of my readers will recall my shot across the bow on this one after Japan was downgraded back in January. Smart money would have made a killing on the Forex & Futures Markets after I argued a US downgrade would follow. Some readers even questioned my ‘patriotism’ and suggested that I was rallying for US decline, never realizing that I track the data wherever it leads. The fact is, I’m right about a whole lot of things. As it turned out, Standard & Poor’s (S&P), one of the big three global ratings agency, on Monday followed the data, too, by downgrading its credit outlook from ‘stable,’ to ‘negative’ for United States sovereign debt – better known as US Treasury notes. The decision by S&P’s sovereign debt analyst, Nicola Swann – known cynically by some traders as the new ‘Black Swann’ – to downgrade US sovereign debt outlook roiled Global Markets, underscoring the growing view that America is a superpower in decline. It is the first time since S&P first assigned ratings in 1989 that the US has been given an outlook other than stable. Among other concerns, Swann cited the staggering US debt ($14.3 Trn and growing), the burgeoning Federal budget deficit, and citing a risk that Washington gridlock and partisan politics as evident lack of will to find agreement on a credible plan to address the nation’s fiscal mess. While the rating agency maintained, for now, the nation’s sterling ‘AAA’ treasury bond credit rating, it said the US Congress has not yet made clear how it will tackle the nation’s long-term fiscal crisis. S&P said the move signals at least a one-in-three chance that it will further cut its rating on the US Government debt, and its ability to meet its obligations within the next two years. “Because the US has, relative to its AAA peers, what we consider to be very large budget deficits and rising government indebtedness, and the path to addressing these is not clear to us, we have revised our outlook on the long-term rating to negative from stable,” S&P said in a release.
A downgrade to the US AAA credit rating will tighten credit markets across the economy, raising the cost of borrowing for all borrowers. That could further derail the struggling economic recovery from the worst recession since the Great Depression era last century. Despite the potential implications, long-term US Treasury bond prices fell as rates rose, while major global stock indexes showed a sharper reaction, shedding more than 1% in early trade. Outstanding public U.S. debt has swelled to more than 60% of total output (GDP) in the aftermath of the global economic crisis precipitated largely by Wall Street greed and irresponsibility. With a Federal budget deficit at nearly 10% of GDP, the total is expected to grow.
Interactive Media: Comparing Global Sovereign Debt Ratings
The Obama administration last week announced plans to trim $4 trillion from the budget deficit over the next 12 years, mostly through spending cuts and tax hikes on the rich. A top administration official reiterated U.S. commitment to act on Monday and said S&P underestimated that resolve. In a media blitz following the announcement by S&P the official line was: “We believe S&P’s negative outlook underestimates the ability of America’s leaders to come together to address the difficult fiscal challenges facing the nation,” said Mary Miller, assistant Treasury secretary for financial markets. Meanwhile her boss, Tim Geithner, the US treasury secretary, shrugged off warnings, saying there was “no risk” of a downgrade to US public finances as he sought to reassure Wall Street that the world’s largest economy would be able to maintain its highly prized AAA rating. Geithner also insisted that the US Congress – who holds the nation’s purse strings – was serious about reducing the Federal budget deficit.
The move will obviously ratchet-up the political fight between the Obama administration and a divided Congress to come up with a credible long-term deficit reduction plan to trim roughly $1.5Trn from the Federal budget deficit. These developments will also likely result in increased US borrowing costs and put further pressure on the US dollar, while the government’s ability to finance the budget shortfall will become more expensive.
The US Dollar managed to hold gains against the Euro on Monday, while traders said debt problems in some European countries were lending some support to the US currency market. Even so, the Greenback has fallen about 5% against major world currencies this year, and record low interest rates together with the S&P negative outlook will do little to make it more attractive, “Even though I don’t think an actual downgrade will occur, in this very sensitive or vulnerable time for the US Dollar, it’s enough to spook global investors from holding or buying Greenbacks.” And as I’ve written here numerous times, this will also likely lead to renewed calls from some sovereign nations who hold their currency reserves in US Dollars to replace the Greenback as the global reserve currency of choice
Meanwhile, in response to declining Greenback expectations, commodities such as oil – which is denominated and traded on global markets in US Dollars – and Gold prices rallied sharply after the announcement, edging closer to the $1,500 per ounce level. On futures markets, gold for June delivery added $6.90 to settle at $1,492.90 on the Comex, a division of the New York Mercantile Exchange. Prices traded as high as $1,498.60 and as low as $1,477.80. Gold and silver had an explosive two-day rally, up 2% and 5.8%, respectively, to close out last week as investors bought gold as protection against inflation and already existing fears about the Dollar’s decline in World markets.
Source: Reuters, Bloomberg Charts: Wall Street Journal
