Free Markets, Free People
The credit rating companies have had a number of European countries on a credit watch for a while. And they made it pretty clear that what the leaders of the EU had cobbled together late last year didn’t answer the mail. So really, this should come as no surprise:
Standard & Poor’s has downgraded France’s credit rating, French TV reported Friday, while several other euro zone countries face the same fate later in the day, according to reports.
"The consequence (if France is downgraded) is that the EFSF cannot keep its triple-A rating," said Commerzbank chief economist Joerg Kraemer.
"That may irritate markets in the short term but wouldn’t be a big problem in a world where the U.S. and Japan also don’t have a triple-A rating anymore. Triple-A is a dying species," he said.
Wow, that’s wonderful, no? “Triple-A is a dying species?” Oh well, moving on…
Triple-A is a dying species because of the obscene spending of welfare-state politicians. We’re supposed to shrug and accept it per the Kraemer’s of the world. This is just an “irritation”, you see.
In reality it is much more than that:
John Wraith, Fixed Income Strategist at Bank of America Merrill Lynch told CNBC the confirmation of a mass downgrade would be another serious step in the crisis and would lead to a serious worsening of sentiment.
"To a large degree it’s widely anticipated," Wraith said. "However, we think the reality of it is going to have a knock-on, ongoing impact on these markets."
“It clearly deteriorates still further the credit worthiness of a lot of the European banks and just keeps that negative feedback loop between struggling banks and the sovereigns that may have to support them if things go from bad to worse in full force,” Wraith added.
A downgrade could automatically require some investment funds to sell bonds of affected states, making those countries’ borrowing costs rise still further.
"It’s been priced in for several weeks, but the market had been lulled into complacency over the holidays, and the new year began with a bounce in risk appetite, thanks partly to a good Spanish auction," said Samarjit Shankar, Director Of Global Fx Strategy at BNY Mellon in Boston.
"But the Italian auction brought us back to earth and now we face the spectre of further downgrades."
Italy’s three-year debt costs fell below 5 percent on Friday but its first bond sale of the year failed to match the success of a Spanish auction the previous day, reflecting the heavy refinancing load Rome faces over the next three months.
As we’ve said for some time, the key to whether this works out or not lies in the bond markets. And this will make the bond markets very uneasy.
Oh, and just to add fuel to the fire. From Zero Hedge:
Last week, when we pointed out what was then a record $77 billion in Treasury sales from the Fed’s custody account, in addition to noting the patently obvious, namely that contrary to what one hears in the media, foreigners are offloading US paper hand over first, there was this little tidbit: "The question is what they are converting the USD into, and how much longer will the go on for: the last thing the US can afford is a wholesale dumping of its Treasurys. Because as the chart below vividly demonstrates, the traditional diagonal rise in foreign holdings of US paper has not only pleateaued, but it is in fact declining: a first in the history of the post-globalization world." Well as of today’s H.4.1 update, the outflow has increased by yet another $8 billion to a new all time record of $85 billion, in 6 consecutive weeks, which is also tied for the longest consecutive period of outflows from the Fed’s Custody account ever. This week’s sale brings the total notional of Treasurys in the Custody account to just $2.66 trillion (down from a record $2.75 trillion) and the same as April of last year. And since the sellers are countries who have traditionally constantly recycled their trade surplus into US paper, this is quite a distrubing development. So while the elephant in the room could have been ignored 4, 3 and 2 weeks ago, it is getting increasingly more difficult to do so at this point, especially with US bond auctions mysteriously pricing at record low yields month after month. But at least the mass dump in Treasurys explains the $100 swing higher in gold in the past month.
Click on over and check out the chart. Lots of questions to be answered for which, apparently, only a few are chasing answers.
While the media is dominated by political races and urinating Marines, this little drama is passing by almost unnoticed. But trust me, it’s effect, should everything collapse as it may, will be profoundly noticed.
As expected global market reaction to the US credit downgrade has been anything but positive.
Global stock markets sank again Monday as worries over the downgrade of U.S. debt outweighed relief at a European Central Bank pledge to buy up Italian and Spanish bonds to help the two countries avoid devastating defaults.
European markets shed their early momentum and losses were heavy in Asia. Most stocks were trading sharply lower amid mounting fears over the opening of U.S. markets, when traders will have their first chance to respond to Standard & Poor’s momentous decision to lower its triple A rating for the U.S.
"The reverberations from S&P’s downgrade are still being felt across the globe," said David Jones, chief market strategist at IG Index.
The European Central Bank’s buy of Italian and Spanish bonds – two Euro countries in deep financial trouble – at first seemed to allay the expected downturn. However that was later reversed and global markets saw a sharp downturn.
At this time one can only speculate what will happen in US markets, but the global sell off is not a good sign.
Monday’s trading came after one of the worst market weeks since the collapse of U.S. investment bank Lehman Brothers in 2008 – around $2.5 trillion was wiped off global stocks last week.
In Europe, Britain’s FTSE 100 index of leading British shares was down 1.7 percent at 5,157 while France’s CAC-40 fell 1.6 percent to 3,227. Germany’s DAX was 2.3 percent lower at 6,091.
Sentiment in Europe was hurt by an expected sell-off at the U.S. open – Dow futures were down 1.8 percent at 11,196 while the broader Standard & Poor’s 500 futures fell 2.1 percent to 1,173.
The one bright spot in an otherwise dismal picture is the US Treasuries market. And “bright spot” is a relative term considering the rest of the markets:
So far, the S&P downgrade doesn’t seem to be having too much of an impact on U.S. government bonds, known as Treasuries. The worry has been that the downgrade would prompt investors to demand more, but the yield on ten-year Treasuries has actually fallen.
"Early market reactions suggest that the treasury market will remain well supported," said Jane Foley, an analyst at Rabobank International. "Even though there may be no sharp sell-off in treasuries this week, S&P’s decision should at least provide a signal to the U.S. government that it may be foolhardy to continue to take its creditors for granted indefinitely."
Two points. One – yes, it should provide such a signal. However, if that signal isn’t acted upon and acted upon swiftly, then two – the treasury market will not remain well supported. Interest rates will rise on demand by investors and servicing our debt will cost more and more.
To add more fuel to the fire, there’s this:
"Investors are concerned about a rising risk of global recession, credit downgrades especially now in the eurozone, such as France, the threat of a major bank bust and a global liquidity trap as investors stay in cash," said Neil MacKinnon, global macro strategist at VTB Capital.
So much to watch and consider. While this may not be the most interesting news to read about, none is more vital. The problems in both Europe and the US have a far reaching effect on global markets. And they will have an effect, at some point, on everyone’s wallet. We’re in uncharted territory here, and unfortunately, there are no easy and painless ways to solve these problems.
First among the reactions globally was that of China:
China bluntly criticized the United States after the S&P ratings cut to AA-plus, saying Washington had only itself to blame and calling for a new stable global reserve currency.
"The U.S. government has to come to terms with the painful fact that the good old days when it could just borrow its way out of messes of its own making are finally gone," China’s official Xinhua news agency said in a commentary.
Xinhua scorned the United States for a "debt addiction" and "short sighted" political wrangling. China, it said, "has every right now to demand the United States address its structural debt problems and ensure the safety of China’s dollar assets."
"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," Xinhua said.
If you think it is bad now, consider our predicament if the dollar was to be replaced as the new global reserve currency. However it is ironic to be lectured by the Chinese on economic matters given their ideological bent. Communists telling Capitalists (pseudo anyway) how they should conduct their business.
France, on the other hand is expressing faith in the US’s ability to get its house in order, as is Poland’s Prime Minister:
France’s Baroin said France had faith in the United States to get out of this "difficult period." Friday’s U.S. unemployment numbers were better than expected and so things were heading in the right direction, he said.
"One should not dramatis, one needs to remain cool-headed, one should look at the fundamentals," he told France’s iTele.
"There is no need for panic," Polish Prime Minister Donald Tusk said. "We will see in August, and maybe more intensively in September what the effects for the world economy will be."
Of course, with the huge problems in Europe, both France and Poland are inclined to play down the significance of a US downgrade. And more interesting than what will happen later this month or next may be what happens on Monday, the first day global markets will mark their reaction to the US credit downgrade:
Because the S&P move was expected, the impact on markets may be modest when they reopen on Monday. But the ratings cut may have a long-term impact for U.S. standing in the world, the dollar’s status and the global financial system.
"The consequence will be far reaching," said Ciaran O’Hagan, fixed income strategist at Societe Generale in Paris.
"It will weigh on secure assets. The bigger reaction will be on risky assets, including equities and on agencies (Freddie Mac, Fannie Mae) and states backed directly by the federal government."
But he added: "U.S. Treasuries will remain a benchmark. This is a ship which takes a long time to turn around."
Norbert Barthle, a budget expert for German Chancellor Angela Merkel’s conservatives, said the downgrade would certainly provoke further turbulence in markets.
Everything mentioned is very important to the future of the US economy and its financial health. Unfortunately most of it is negative. In the next few months we’ll see how this shakes out, but at this point, even the optimists are pessimistic.