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Posts tagged ‘United States Treasury security’

Curb your enthusiasms?

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So, the NTMA have issued a (welcome) note that Ireland is to resume auctions of T-bills. The note states that “on Thursday 5 July 2012. The NTMA will offer €500 million of Treasury Bills with a three-month maturity in its first such auction since September 2010.”

The details of the auction on 5 July are as follows:
• Auction size: €500 million.
• Maturity: 15 October 2012.
• Auction opens: 9:30 a.m.
• Auction closes: 10:30 a.m.
• Settlement date: 9 July 2012.
This is potentially (pending results of sale, namely yield, volume and percentage allocation to non-captive banks and funds) a minor positive for Ireland. Minor, because

  • Bills are NOT bonds – bills are short-term instruments, traditionally under 12 months maturity (bonds are over 1 year maturity).
  • Bills issued currently fall to mature within the period of existent EFSF funding programme, so in effect there will always be funds to cover these, short of a catastrophic collapse of the euro during the duration of the bills.
  • Issuance of bills has nothing to do in terms of signaling the state of public finances health or economic conditions health of the issuer, as both Greece (see here) and Portugal (here) have issued these during their tenure in the rescue programmes.
  • Portugal issuance (linked above

Treasuries and Derivatives Blow Up? So Where Do You Go …

By Anthony Wile (Daily Bell)

Here’s some interesting news along the lines of “man bites dog.” According to a recent Reuters article, US financial advisors are actually growing leery of US Treasury bonds.

This is almost unheard of and one could certainly make a case that it is a sign of most unsettled times. Ordinarily, financial advisors, especially those in the US, are disposed to provide Treasuries for most every ill.

They are seen as repositories of value, security and liquidity – and this perspective has been preached relentlessly to the average US consumer.  And yet now we now find a much different perspective, being reported by Reuters:

It’s the newest market riddle: where do you go for safety when the traditional option could be in a bubble?

With fiscal problems in Europe once again leading to sharp drops in global stock markets, many investors are seeking out stable assets that can both protect their principal and generate an income stream to keep up with inflation.

full article at source: http://www.thedailybell.com/3883/Anthony-Wile-Treasuries-and-Derivatives-Blow-Up-So-Where-Do-You-Go

The Debt Supercycle Reaches Its Final Chapter

The TED spread – an indicator of credit risk –...
Image via Wikipedia

By James J Puplava CFP

 

This year will mark my 32nd year in the business. I began my career in 1980 after spending several years in corporate life, which I did not find to my liking. I had too much of an independent streak and eventually came to the realization that I’d be much better off starting my own business. When I entered the financial world interest rates were beginning to peak, as the long upward climb in inflation was coming to an end under the leadership of Paul Volker at the Fed. It is hard to believe today that interest rates on treasuries were as high as 15.7%. The yields on money market funds were over 18%. Inflation rates were over 14%, with oil prices at $40 a barrel. Gold and silver would eventually peak at $850 and $50 an ounce, respectively.

Where the Debt Supercycle Begins

I spent my first decade in the business as a broker before transforming my business to a fee-based money management firm. All I sold in the 1980’s was fixed income. Who wanted to invest in stocks when you could get double digit returns in guaranteed deposits at a bank or by investing in government debt? I still remember one of my first trades—a 10-year treasury note paying a 15% interest rate.

full article at source.:http://www.financialsense.com/contributors/james-j-puplava/debt-supercycle-reaches-its-final-chapter

The rent our Government is paying Treasury Holdings

By paul maher

The rent our Government is paying Treasury Holdings (aka Johnny Ronan) for the new Convention Centre is €25 million per annum for the next twenty years. That’s €500million. This would make a significant dent in the nearly €1 billion (MoS) of Treasury debt that NAMA (We) took over.Lawyers would rightly claim reneging on this rent would be illegal. But the rule of law and the “Democratic” will of the people (remember Lisbon II ?) have been subverted and trampled into the ground by successive Bertie & Biffo led FF governments. With that in mind, I say “Go ahead! Divert the funds” into Government coffers along with the “sheltered” monies from other dodgy developers/builders/bankers.

As expected, this Government has turned out to be no different than the previous three. They promised to represent the “People” when in fact they now cowtow and genuflect to everyone and everything from the likes of Merkel, Sarkozy, Rehn, Johnny Ronan & Seanie Fitz, to the ECB/IMF, Goldman Sachs, Deutsche Bank et al. Politicians are a global plague. If we can’t eradicate them, let us at least control them. In Switzerland, the People are in charge. We could do worse than follow their example!

Paul Maher,

Castle St., Roscrea,Co.Tipp

 

From “Favorable” to Fear

By James J Puplava CFP

Fear has returned with a vengeance to the financial markets once again. The media has elevated the threat levels and seems bewildered. Why the sudden change? Less than a month ago it looked like markets were ready to break out to new highs. What went wrong? Is it America’s debt problems—the risk of default? Two weeks ago it was all about the debt ceiling debate, and then fears turned toward Europe. Now it is the downgrade of US Treasury debt. America’s pristine AAA credit rating has been lost.

The answer is much broader than this. Sovereign debt issues have risen to the surface and that’s what makes the current environment dangerous. However, what is happening now goes beyond the market’s debt fears. Behind them is a growing recognition that the economy may be heading back into recession again and it appears the government is impotent to prevent it. QE1 brought us back from the abyss. The stimulus was supposed to supercharge the economy and bring down the unemployment rate. QE2 was sold as another “insurance policy” to pull the economy out of a soft patch.

The stimulus is winding down and QE2 ended in June. The markets seem to be asking: What do we have to show for all this effort? Unemployment is rising and economic growth remains anemic and is at risk of another recession.

unemployment graph from january 2009

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Source: Bloomberg

At the end of the government’s 2008 fiscal year, US debt stood at $9.986 trillion. On the day of this writing, August 8th, at 2PM Pacific Standard Time it stood at $14.587 trillion and is growing by $4.02 billion every day. The unemployment rate stands at 9.1%. It went down last month—not because more jobs were created, but because more workers “dropped out of the labor force,” meaning they gave up on their prospects to find work. Despite over $4.6 trillion in new debt and a $2 trillion expansion in the Fed‘s balance sheet, unemployment rose by close to 2%, economic growth is tracking at less than1%, and the stock market is below the levels set at the commencement of QE2—so much for Mr. Bernanke’s “wealth effect.”

In my opinion what the markets are signaling here is the “pricing in” of another US recession and all of the fallout this will generate. Below is a graph of the LEIs (leading economic indicators) and the S&P 500.

ECRI LEI & S&P graph

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Source: Bloomberg

Notice the parallel track. The LEIs began to rollover in April and that is when the stock market began to top out. The media is citing debt fears as the reason behind the downturn, but they are wrong. Treasury yields have fallen back down to levels not seen since the winter of 2008, yet if investors were worried over US solvency they wouldn’t be buying Treasuries. More likely is that the drop in “risk assets” reflects a corresponding decline in the LEIs and the declining prospects for US and global economic growth. Q1 economic growth was revised downward to 0.4% from an earlier estimate of 1.9%. Q2’s first initial estimate came in at 1.3% versus consensus of 1.8%.

The experts have all downgraded GDP estimates for the year to the 2.5–3% range. Despite the evidence to the contrary, economists, Fed officials, and the Administration are still calling for a strong second-half recovery. The slack economic growth is being blamed on one-off events such as the Middle East uprisings, the Fukushima earthquake, and the rise in oil prices in late spring. We at PFS Group do not buy the political/financial balderdash of a strong second-half recovery. Unless something changes in the way of additional stimulus or a new form of QE3, we expect the economy to weaken further and the unemployment rate to continue to rise. We also expect further downgrades of US Treasury debt.

Government Meddling in Markets and a Worsening Economy

Government intrusion into the economy and the markets have actually made things worse, not better. The economic stats confirm this assertion. The unemployment rate is higher, economic growth is lower (2007–2010 real GDP decreased at an annual rate of -0.3 %), and inflation rates have grown since the bottom of the recession. All we have to show for this intrusion into the economy by the government is a higher inflation rate.

What accounts for this mismatch between economic strategy and economic outcome? The old economic and financial models seem to be breaking down. They were designed to work in an economy that was unencumbered by debt. The consumer debt supercycle ended in 2008. We moved on to the government debt supercycle which will also come to an end. We are now entering the final stages of the endgame which will lead to an earth shattering currency crisis centered on the US dollar.

Despite numerous interventions all we have to show for our efforts is a series of bubbles and crashes. As the chart       below demonstrates, every Fed rate-raising cycle has ended up breaking something either in the economy or in the       financial markets. There have also been instances when the Fed has broken both the economy and the financial markets through a series of raising and lowering interest rates (percentage rate of interest plotted on y-axis).

past financial crises & fed tightening cycles

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Source: http://www.financialsensearchive.com/stormwatch/2006/1215.html

THE FOLLOWING INFORMATION IS FROM PRIOR CLIENT-ONLY MEETINGS

Easy monetary policy allowed investment bubbles to form, while a policy-tightening cycle brought about the demise of each bubble. All investment bubbles require a backdrop of easy money. Once a bubble is inflated, policy tightening causes it to burst. As a bubble deflates the central bank steps in again, adding liquidity to temper the economic slowdown.

This pattern of boom-and-bust cycles has been operating with success for the better part of a century. It is now coming to an end. Because the downturns were tempered with more liquidity, the malinvestments of previous booms were never cleansed from the system. Instead of economic cleansing, growing debt imbalances have been allowed to accumulate.

Higher consumer debt levels and the new reality of less available credit are reshaping spending patterns and lifestyles throughout the US economy. This is just one of the numerous macro trends that are reshaping global economies. There are other macro factors that are influencing economic outcomes and making our economic models outdated.

  1. Globalization, communication, and technology (results in synchronization of global economies and markets)
  2. The credit bubble and developed-world fiscal crises (negates fiscal/monetary policy impact on new credit creation)
  3. The rise of the emerging industrializing economies, especially BRIC countries (creates enormous pressure on resources, especially energy and food)
  4. Fed monetary policy and the dollar peg (serves as a transmission mechanism for transferring US inflation rates throughout the rest of the world leading to dollar devaluation)

It should be clear to the reader by now that something is amiss with economic policy and the concomitant prescriptions that accompany it. To sum up, what used to work isn’t working anymore. Even worse, policymakers keep advocating the same policy prescriptions, expecting different results each time they are applied. Some would argue that this is the definition of neurosis or insanity.

The result is that our debt imbalances keep growing and are clearly on an unsustainable path. The 2007–2008 financial crises are a glimpse of what lies ahead in our future. What transpired during 2007–2008 is simply a warm-up act for a much bigger economic storm that is directly ahead of us. What’s more, there doesn’t seem to be the political will to confront it.

Quantifying Stress on Financial Systems

As a result of the 2007–2008 credit crises our firm developed a proprietary financial stress index to alert us of forthcoming financial storms. We developed it in response to the Lehman Brothers bankruptcy and the financial domino effect that followed in its wake. It is one tool we have used to navigate subsequent storms. Last summer it triggered, along with other aspects of our model, a rise in cash levels to 40%. The PFS Group Financial Stress Index turned negative last Friday, the 4th negative signal since 1998 (based on our backtesting). Portfolio cash levels are now elevated.

PFS group financial stress index & multiple stress index graphs

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Source: Bloomberg

stress components

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Source: Bloomberg

The greatest stress is coming from the equity market (-2.62), followed by the currency markets (-1.08), and the bond markets (-0.75). What drives the model is the fallout caused in financial markets by the same growing burden at all levels within various economies: government debt, consumer debt, and corporate debt.

It is time to discuss financial risk and what is driving our financial stress model into negative territory. On the political front, the extension of the debt limit debate is over. Nothing meaningful was done, so it should come as no surprise that S&P just downgraded US Treasuries. Government-controlled and guaranteed entities Fannie Mae and Freddie Mac were also downgraded. All the downgrades were from AAA to AA+. The US government rescued the two mortgage giants in September 2008 and has funded them since the financial crisis. Both entities own and guarantee about half of all US mortgages and nearly all new mortgages issued since the financial crisis began. The other two major rating agencies, Moody’s and Fitch, are currently reviewing US Treasury debt and will have their own rating appraisal of it. S&P still has US Treasury debt on credit watch for possible further downgrades depending on the next round of budget cuts this November.

As the US economy weakens, another round of wasteful government spending programs seems unlikely. The American public wants to see deficits reduced. Therefore, another round of wasteful government spending programs is off the political table for the moment. The political environment in Washington has changed from stimulus spending to budget cuts. The same shift is taking place at the state and local levels, with many state and local governments shedding jobs. Over 575,000 state and local government jobs have been lost since the peak in 2008 (see graph below).

government payrolls

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Source: Bloomberg

gov't job loss weigh on the recovery

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Unfortunately, the fiscal picture for most states doesn’t look any better for next year. Fiscal Year 2012 (which began on July 1st) will be the fourth consecutive year of painful budget cuts. Furthermore, an interesting dichotomy is beginning to emerge in the municipal bond markets. States that are shedding jobs they can’t afford to support are being rewarded by the markets, which are showing appetite for their lower bond yields—the capital markets are rewarding fiscal responsibility.

Unlike the Federal government, states can’t print money. They must balance their books or borrow money to pay their bills. Responsible states are financing at lower interest rates while irresponsible states—and I include California, my state of residence, in this category—are seeing their bond ratings lowered and are having to finance at higher interest rates, which further exacerbates their deficits.

Washington is also beginning to run into its own fiscal problems. Our major creditors such as China are calling for more fiscal discipline and less money printing. International agencies from the World Bank, to the IMF, to the United Nations are calling for responsible fiscal and monetary policy. There is also talk about replacing the dollar as the world’s reserve currency. On the day this was written, British Business Minister Vince Cable backed China’s call this last weekend for a new stable global reserve currency to replace the US dollar.

So far the message doesn’t seem to be resonating within the Administration or with Congress. Most budget cuts are “smoke and mirrors,” with the majority of cuts taking place in the later years of this decade. Outside the President’s Deficit Commission and the Paul Ryan Plan, there doesn’t seem to be the stomach to tackle America’s deficit crisis. The tendency is to kick the can down the road until after the next presidential election when the hard choices will be forced on the next administration, whoever that turns out to be.

Our economic problems can be boiled down to one issue: too much debt. As shown in the following graphs the US’s debt levels have accelerated over the last three decades to unsustainable levels. As mentioned earlier, as of this writing—Monday, August 8th, at 2PM Pacific Standard Time—the national debt was $14.587 trillion, and our national debt is growing at a rate of $4.02 billion per day!

The picture doesn’t look much better at the state and local levels as shown below.

us state and local debt outstanding

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The following graphs illustrate personal and corporate debt, which are also worrisome.

us consumer debt

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Even more troublesome is the nation’s total debt outstanding as of yearend 2010: $52 trillion! But that isn’t the real story. The real story is that our debt is growing faster than our economy. Between the year 2001 and 2010 our national debt grew from $28 trillion to $52 trillion. During that same period US GDP went from $10 trillion to $14 trillion. Debt grew by $28 trillion while economic growth increased by $4 trillion. In other words: It is taking $6 of debt to produce $1 of economic growth. This is clearly unsustainable.

As bad as those debt figures appear, they are only part of the story. These figures don’t include our unfunded entitlement liabilities, which are estimated to be another $60 trillion as of 2010. According to economist John Williams of Shadow Government Statistics (SGS), the 2010 Financial Report of the United States Government showed a GAAP-based deficit for 2010 of $2.08 trillion versus the reported deficit of $1.254 trillion. Broader GAAP-based federal deficits, including Social Security, Medicare, and Medicaid have been averaging between $4 and $5 trillion per year since 2008.

Buried in the back pages of the debt extension debate have been the recent findings of the Social Security and Medicare trustees who have basically said both programs are insolvent. Even the US Post Office is broke, hemorrhaging $2–3 billion in losses every quarter. The Post Office recently announced it would stop making payments to its pension plan.

As shown in the following graph taken from the President’s bi-partisan National Commission on Fiscal Responsibility and Reform, the national debt is on an unsustainable path.

2010 united states statement of net costs

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Financial Repression: The Only Way Out?

So how are we going to dig our way out of this mess?

According to professors and authors Kenneth Rogoff and Carmen M. Reinhart there are only five choices available to governments that are heavily laden with debt.

  1. Economic      growth
  2. Fiscal      adjustments/austerity plans
  3. Default      or restructuring of debt
  4. Sudden      burst of inflation (hyperinflation)
  5. Steady      dose of financial repression accompanied by an equally steady dose of      inflation.

It is obvious that the US will be unable to “grow” its way out of its debt problems. To do that would take economic growth rates of 10% or more—these growth rates would have to be sustained for several decades.

The more likely approach is a combination of strategies that will involve spending cuts, tax increases, and a healthy dose of inflation. The US will likely be inclined to use the same strategy that it used to reduce our debt after World War II. Economists refer to this strategy as “financial repression.” Financial repression involves keeping interest rates artificially low and running a higher inflation rate. The artificially low interest rates enable the government to finance its deficits at an artificially low rate of interest. This reduces the size of the deficit and the interest costs the government has to pay its bond holders. At the same time, running higher rates of inflation allows the government to grow the economy in nominal terms (GDP increases as the cost of goods and services rise due to inflation), which reduces the size of the deficit when compared to the nominal value of GDP (see graph below for an illustration of this point).

gross federal debt in 20th century

The problem for the government is: How do you fool investors and holders of government bonds so they keep buying and holding your debt?

You do this by understating the true rate of inflation. This is done by tinkering with how the Consumer Price Index (CPI) is computed. It should come as no surprise that as Congress grapples with entitlement costs they have suggested using a different rate for the CPI used to compute annual cost of living adjustments (COLA). By using various statistical measures, the Bureau of Labor Statistics (BLS) can alter the way the CPI is measured and computed. They did this in the 1990s in order to reduce Social Security and retirement costs. They are going to do this again.

At a personal level you are going to see your cost of living continue to rise. However, in the financial media, politicians and Fed governors will likely continue to report low levels of inflation. It is all part of a “confidence game” the government needs to play with the markets and bond investors to keep the “true” state of the fiscal crisis from becoming apparent. I would like to illustrate this point in the CPI graphs shown below.

The first graph is the current CPI as reported by the BLS (from www.bls.gov/cpi). Year over year it is annualizing at a 3.6% rate. The next graph is taken from John Williams’ Shadow Government Statistics (www.shadowstats.com). Notice the difference between the two inflation rates. The government is reporting an annualized rate of 3.6% while SGS reports the real inflation rate is running at an annual rate of 7.5%.

BLS CPI

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SGS alternate inflation rate

According to SGS’s calculations, the US Government is intentionally understating the inflation rate by almost 50%.

The second part of financial repression involves keeping interest rates capped. This is done by the Fed printing money or essentially buying the government’s debt. This can be seen in the graph of the Fed’s balance sheet and the table of Treasury yields (below).

us treasury actives curves

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Source: Bloomberg

In my recent podcasts I have been highlighting the possibility of the US government pursuing a strategy of financial repression to dig itself out of its debt problems. That is why I expect that the next round of monetary stimulus is more likely to involve targeting interest rates, a policy implemented directly after World War II. It worked back then. The question now is: Will this policy work again and produce the same results? Financial repression eventually led the US to eliminate gold backing of the dollar. It may be more difficult to implement this time around. The Fed no longer dominates global monetary policy. It may find pulling the familiar monetary levers produces very different outcomes. A loose monetary policy that leads to a lower dollar helps US exports. However, the US economy is consumption-based. A lower dollar leads to higher commodity and import prices which further reduce consumer discretionary income. Therefore, while a lower dollar may help US exports it reverberates back in the form of higher inflation rates which harms consumption; a broken-down model which is leading to a broken-down economy.

It should be apparent by now that US deficits and debt levels are unsustainable. The $64 trillion dollar question right now is what the next policy response will look like. Given a slowdown in the US economy and the risk of another recession, the growing debt dominoes in Europe, and a slowing Chinese economy, look for a coordinated policy response on a global scale. The Fed and other central banks around the world may act together to orchestrate a massive round of reflation. This would cause a complete reversal in the equity and commodity markets, pushing the dollar to record lows and launch precious metals into orbit.

The bad news is that each new policy response will be met with higher commodity prices and inflation levels. This will be bad news for global consumers and good news for precious metals, commodities, and hard currencies.

Like the rest of the market, I’ll be watching Fed monetary policy and US fiscal policy for cues as to my next move in my clients’ portfolios.

The budget should be balanced, the treasury should be refilled, public debt should be reduced, the arrogance of officialdom should be tempered and controlled, assistance to foreign lands should be curtailed lest Rome become bankrupt. The mobs should be forced to work and not depend on govern­ment for substance. —Taylor Caldwell, A Pillar of Iron, a fictionalized account of the life of Cicero

source:http://www.financialsense.com/contributors/james-j-puplava

Comment:

This is one of many excellent article on the US Economy and Markets  do follow the link to source to view more excellent articles

 

 

China Blasts U.S. Debt Problems, Urges New Global Reserve Currency

By the daily Bell

China on Saturday condemned the “short-sighted” political wrangling in the United States over its debt problems and said the world needed a new global stable reserve currency. “China, the largest creditor of the world’s sole superpower, has every right now to demand the United States address its structural debt problems and ensure the safety of China’s dollar assets,” China’s official news agency said in a commentary. “International supervision over the issue of U.S. dollars should be introduced and a new, stable and secured global reserve currency may also be an option to avert a catastrophe caused by any single country,” it said. – Reuters

Dominant Social Theme: It’s time to let Christine Lagarde and the other “wise leaders” at the IMF run the world’s money.

Free-Market Analysis: Well, this certainly comes as no surprise. We have been ringing the bell on this one for a while now. In fact, we ran a staff report back in March 2009, titled China Wants IMF to Manage New One-World Currency. The essence of what we said in that article, as well as many others dealing with Money Power’s insatiable desire to fasten a global currency yoke on the entire world’s population, is that out of the fiat-manufactured chaos we have today, it is likely that global order will be promoted as the cure to all our monetary ills. The IMF, a globalist organization to be sure, along with the World Bank, will be marketed by the establishment politicians, NGO think tanks and mainstream media outlets as the only logical way to alleviate the markets of their instability and overall confusion. The eurozone experiment alone should be enough of a wakeup call – for anyone that cares to see – that stitching together a bunch of systemically bankrupt nations’ fiat currencies does nothing to alleviate the rot inherent in the design and nature of the money-stuff system itself. We truly hope the world escapes from the grasp of the globalists’ fiat-fangs and that this plan of unification does not become a reality. What the world needs, in our opinion, are private currencies competing in a free-marketplace where governments have no involvement in either the issuance of currency or its management. Let the market decide what to use as money and keep the State and unelected global government agencies out of it.

source: http://www.thedailybell.com/2771/Daily-Bell-Briefs-China-IMF-World-Currency-US-Debt-Downgraded-ECB-Intervention

Comment:

 

Allowing Lagarde  of the IMF and her bad run a world currency is
definitely not the answer to the world’s financial problems .Things are bad but
we are not fools ,just look at the mess Europe is in ,all we will be doing is
allowing a new super select group of untouchables dictate to the world terms
that suite the super rich and well connected and we have enough of this in Ireland
.These are the same people that are telling us Austerity is the answer and at
the same time they tell us we need to grow our economies .But their imposed
austerity measures are in fact squeezing every drop of available credit out of
the economy and without credit for small business to restock and upgrade we
might as well whistle dixi for our food on the table !If Austerity worked all
the poor countries would be in the middle of boom times .No a world currency on
these people’s terms is the road to eternal financial slavery. No Thanks !

 

Standard & Poor’s downgraded the U.S.’s AAA credit rating

Standard & Poor’s downgraded the U.S.’s AAA credit rating for the first time, slamming the nation’s political process and criticizing lawmakers for failing to cut spending enough to reduce record budget deficits.

S&P lowered the U.S. one level to AA+ while keeping the outlook at “negative” as it becomes less confident Congress will end Bush-era tax cuts or tackle entitlements. The rating may be cut to AA within two years if spending reductions are lower than agreed to, interest rates rise or “new fiscal pressures” result in higher general government debt, the New York-based firm said yesterday.

Lawmakers agreed on Aug. 2 to raise the nation’s $14.3 trillion debt ceiling and put in place a plan to enforce $2.4 trillion in spending reductions over the next 10 years, less than the $4 trillion S&P had said it preferred. Even with the specter of a downgrade, demand for Treasuries surged as investors saw few alternatives amid concern global growth is slowing and Europe’s sovereign debt crisis is spreading.

“The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics,” S&P said in a statement late yesterday after markets closed.

U.S. Response

The U.S. immediately lashed out at S&P, with a Treasury Department spokesman saying the firm’s analysis contains a $2 trillion error. The spokesman, who asked not to be identified by name, didn’t elaborate, saying the mistake speaks for itself.

Moody’s Investors Service and Fitch Ratings affirmed their AAA credit ratings on Aug. 2, the day President Barack Obamasigned a bill that ended the debt-ceiling impasse that pushed the Treasury to the edge of default. Moody’s and Fitch also said that downgrades were possible if lawmakers fail to enact debt reduction measures and the economy weakens.

“This move should not be much of a surprise to markets, though the timing is at a point where market sentiment is fragile after the drop in stocks this week,” said Ajay Rajadhyaksha, a managing director at Barclays Capital in New York. “What really matters is whether the markets are willing to ‘downgrade’ the U.S. bond market. As this week’s move showed, U.S. Treasuries remain the flight-to-quality asset of choice.”

Asian Investors

Asian investors are likely to retain their Treasuries holdings for now, with options limited by the region’s foreign-exchange rate policies. Japan, the second-largest international investor in American government debt, sees no problem with trust in the securities, a Japanese government official said on condition of anonymity.

Policy makers from China to Japan to Southeast Asia are lured to Treasuries as a result of efforts to stem gains in their currencies against the dollar, which would impair export competitiveness. China has accumulated $1.16 trillion in the securities and the nation’s official Xinhua News Agency said in a commentary that the U.S. must cure its “addiction” to borrowing.

“They won’t be happy about it, but Asian central banks will just have to hold on and stick it out,” said Sean Callow, a senior currency strategist at Westpac Banking Corp. in Sydney.“There is pressure on them to hold on to liquid assets and there is nothing more liquid than the Treasury market. At least Treasuries have been doing well and they aren’t holding on to distressed assets.”

U.S. Economy

S&P’s action may hurt the U.S. economy over time by increasing the cost of mortgages, auto loans and other types of lending tied to the interest rates paid on Treasuries. JPMorgan Chase & Co. estimated that a downgrade would raise the nation’s borrowing costs by $100 billion a year. The U.S. spent $414 billion on interest expense in fiscal 2010, or 2.7 percent of gross domestic product, according to Treasury Department data.

“It’s a reflection of the fact that we haven’t done enough to get our fiscal house in the order,” Anthony Valeri, market strategist in San Diego at LPL Financial, which oversees $340 billion, said in an interview before the cut. “Sovereign credit quality is going to remain under pressure for years to come.”

The agreement between Republicans and Democrats raised the nation’s debt ceiling until 2013 and threatens automatic spending cuts to enforce the $2.4 trillion in spending reductions over the next 10 years.

Even with the accord, S&P said the U.S.’s debt may rise to 74 percent of gross domestic product by year-end, to 79 percent in 2015 and 85 percent by 2021.

S&P also changed its assumption that the 2001 and 2003 tax cuts enacted under President George W. Bush would expire by the end of 2012 “because the majority of Republicans in Congress continue to resist any measure that would raise revenues.”

American Policymaking

“More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating,” S&P said.

S&P put the U.S. government on notice on April 18 that it risked losing the AAA rating it had since 1941 unless lawmakers agreed on a plan by 2013 to reduce budget deficits and the national debt. It indicated last month that anything less than $4 trillion in cuts would jeopardize the rating.

“There was still a very narrow cross section of common ground between the parties and we don’t think that this agreement really changes that equation,” David Beers, a managing director of sovereign credit ratings at S&P said in a Bloomberg Television interview.

Capital Weightings

The treatment of Treasuries and other securities backed by the U.S. in terms of risk-based capital weightings for banks, savings associations, credit unions and bank and savings and loan companies won’t change, the Federal Reserve and bank regulators said in a statement following the downgrade.

Obama has said a rating cut may hurt the broader economy by increasing consumer borrowing costs tied to Treasury rates. An increase in Treasury yields of 50 basis points would reduce U.S. economic growth by about 0.4 percentage points, JPMorgan said in a report, citing Fed research and data.

“The minute you start downgrading away from AAA, you take small steps toward credit risk and that is something any country would like to avoid,” Mohamed El-Erian, chief executive and co-chief investment officer at Pacific Investment Management Co., said in a Bloomberg Television interview before the announcement.

Treasury Yields

Ten-year Treasury yields fell to as low as 2.33 percent inNew York yesterday, the least since October. Yields for the nine sovereign borrowers that have lost their AAA ratings since 1998 rose an average of two basis points in the following week, according to JPMorgan.

Treasury yields average about 0.70 percentage point less than the rest of the world’s sovereign debt markets, Bank of America Merrill Lynch indexes show. The difference has expanded from 0.15 percentage point in January.

Investors from China to the U.K. are lending money to the U.S. government for a decade at the lowest rates of the year. For many of them, there are few alternatives outside the U.S., no matter what its credit rating.

“Yields are low in the face of a downgrade because there is nowhere else for people to go if they don’t buy Treasuries because they want to be in safe dollar assets,” Carl Lantz, head of interest-rate strategy at Credit Suisse Group AG, one of 20 primary dealers that trade directly with the Fed, said before the announcement.

Bond Dealers

The committee of bond dealers and investors that advises the U.S. Treasury said the dollar’s status as the world’s reserve currency “appears to be slipping” in quarterly feedback presented to the government on Aug. 3.

The U.S. currency’s portion of global currency reserves dropped to 60.7 percent in the period ended March 31, from a peak of 72.7 percent in 2001, data from the International Monetary Fund in Washington show.

“The idea of a reserve currency is that it is built on strength, not typically that it is ‘best among poor choices’,”page 35 of the presentation made by one member of the Treasury Borrowing Advisory Committee, which includes representatives from firms ranging from Goldman Sachs Group Inc. to Pimco. “The fact that there are not currently viable alternatives to theU.S. dollar is a hollow victory and perhaps portends a deteriorating fate.”

Members of the TBAC, as the committee is known, which met Aug. 2 in Washington, also discussed the implications of a downgrade of the U.S. sovereign credit rating. “None of the members thought that a downgrade was imminent,” according tominutes of the meeting released by the Treasury.

Remaining AAAs

S&P gives 18 sovereign entities its top ranking, includingAustralia, Hong Kong and the Isle of Man, according to a July report. The U.K. which is estimated to have debt to GDP this year of 80 percent, 6 percentage points higher than the U.S., also has the top credit grade. In contrast with the U.S., its net public debt is forecast to decline either before or by 2015, S&P said in the statement yesterday.

New Zealand is the only country other than the U.S. that has a AA+ rating from S&P and an Aaa grade from Moody’s. Belgium has an equivalent AA+ grade from S&P, Moody’s and Fitch.

A U.S. credit-rating cut would likely raise the nation’s borrowing costs by increasing Treasury yields by 60 basis points to 70 basis points over the “medium term,” JPMorgan’s Terry Belton said on a July 26 conference call hosted by the Securities Industry and Financial Markets Association.

“That impact on Treasury rates is significant,” Belton, global head of fixed-income strategy at JPMorgan, said during the call. “That $100 billion a year is money being used for higher interest rates and that’s money being taken away from other goods and services.”

To contact the reporter on this story: John Detrixhe in New York at jdetrixhe1@bloomberg.net

To contact the editor responsible for this story: Dave Liedtka at dliedtka@bloomberg.net

Comment:

This move is a surprise to me as I did not believe the S&P would have the balls to do so .

This is bad for the markets, expect to see wild gyrations in the Dow .This is the kind of move that could cause the Dow to take a further nosedive down to about 9400ish a 2000 point drop .It’s time to get out or get some more insurance! The new rating of AA+ is not justified with all of the printing going full blast the Americans are already broke many times over and should really have a rating of Junk status . But if this happened we could see global  war.

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