Fitch winks a AAA...

On August 16, 2011, Fitch Ratings confirmed its AAA rating for the US sovereign debt. Whether it was an anti-climactic no-brainer after witnessing the fiasco of the S&P downgrade, or Fitch corporate insight that it may just be too early to throw the towel in on US sovereigns given the response the markets gave to the rival's downgrade is irrelevant except to seers and their jury. In fact,  the sequitur- Treasuries rose in price and equities tumbled,  the dollar surged as capital flowed into the US for the short term was predictable. Meanwhile, an overly cautious European financial system and European AAAs tried to make sense of their own regional fiasco in light of this US resurgence. It was a perfect storm for Fitch to stall on, without sinking.

Analysts Messrs. Riley, Olert, Renwick and Fitch management should be commended for their approach and narrative: 

"The affirmation of the US 'AAA' sovereign rating reflects the fact that the key pillars of US's exceptional creditworthiness remains intact: its pivotal role in the global financial system and the flexible, diversified and wealthy economy that provides its revenue base. Monetary and exchange rate flexibility further enhances the capacity of the economy to absorb and adjust to 'shocks'."

The narrative accompanying the affirmation reflects a humble appreciation of the mission of the Rating Agencies, a subtle recognition that the US financial structure can accommodate internal and external tensions and 'shocks', support the demands of its financial and trade partners, and a realistic understanding of the US position as underpinning the global economic system. It was a reasonable call in the case of the United States- a sovereign that could not default, although Fitch nudged away from that premise by mitigating the controversy with ' the risk of sovereign default remains extremely low.'  Notwithstanding the wink,

...Fitch also wagged the finger

Ten days later,  on  August 25, 2011, Fitch London Research Paper  released its conclusions on the global consequences of a hypothetical "double-dip recession" in the US.  At the time of  the original affirmation, August 16, 2011, Fitch had also confirmed its intentions to review the fiscal state and projections of the US economy in light of the latter's own commitment to reduce its deficit. The position Fitch advocates by its affirmation of the maximum rating is not as daring as some observers would judge. The reserve status of the US currency, the depth of the US markets, and the intrinsic ability of the US to satisfy its monetary obligations vis-a-vis its creditors, even in light of slowing economic growth and domestic political tension-all warrant the Fitch AAA affirmation and the ensuing qualified caution as to an imminent review, given the integral role the US plays in sustaining global economic stability. In this context, the Fitch London Research report is a timely and welcome sequitur to the affirmation of AAA.  It reiterates and confirms the soundness of those fundamental considerations that Fitch tabled and examined in the first instance to arrive at its maximum rating. It also interposes a scenario testing the consequences of a major slowdown in the US economy.  The analysis quantifies the direct, and to a much more limited extent, warns of the second round effects , including inter-financial sector effects, of a hypothetical 'double-dip' recession in the US. Fitch concludes that no country will be insulated from the adverse impact of a further deterioration in US economic activity. First, but not foremost, is China and the combined domino impact of a slowdown in the US and a commensurate drop in GDP in China on world economies will be formidable. The greatest effect of the US slowdown will be on its adjoining geographic trade partners Mexico and Canada, and seemingly the consequence will be 'severe'. The most intense will be to small and open economies. That the healthy state of the US economy is a sine qua non catalyst for any global recovery is emphasized to the point that Fitch underscores that the US dip could tip the major advanced economies into recessions, and this includes a fragile Europe and a taxed Japan. The Fitch announcement out of London preceded the prouncements by the world's leading financial figures at the 2011 Economic Policy Symposium sponsored by the Federal Reserve Bank of Kansas City and held in Jackson Hole, Wyoming  from August 25, 2011 through to August 27, 2011. Not only did it assemble central bankers and senior policymakers, but it also gave the world an opportunity to listen to a battered field's rising stars with daring visions among which named: Mr. Dani Rodrik and Mme.Esther Duflo.

The Fitch release set a balanced and cautious mood for the world's markets and audience, thereby permitting global policymakers to ponder the complexity of a situation that required serious reflection and sound discernment in a reserved setting. 

FitchRating acted very responsibly and very professionally.

h/t Fitch

Mr. Bernanke's Fed. Bravo!!!

The FOMC statement issued Tuesday August 9, 2011 at around 14:15PM was dissented by three committee members. It initially stirred confusion in all markets. Equity markets were taken by surprise as they focused on the bleak economic outlook the Fed suggested.  The Dow was down 200 points, shedding almost 450 points in 30 minutes before recouping after watching the Treasuries' plummets and appreciating the insight that maybe equity yields were favorable investments after all.  At the end of the day, the Dow had rallied back over 600 points. It was a session marked with enormous market volatility. Dow closed the day 430 points higher in the most dramatic session in decades.

The same announcement shook short date (2 years and less) Treasury markets dramatically,  generating yields that camouflage Short date Notes as fed funds- zero coupon- for all intents and purposes, and sent the US dollar into a tailspin against the meek Swiss Franc and roaring Gold,  after market players correctly interpreted that the Fed was capping rates at near-zero for the next 30 months until the end of Mr. Bernanke's term.

Most observers also correctly felt that the Fed intentionally avoided sabotaging already nervous equity markets that were showing promise with substantive earnings and a sufficient capital base. The Fed action was seen as creating favorable portfolio opportunities  for money managers to retain good yielding equity that confirm good earning and dividend profiles. The Fed idea was not to undermine potential economic benefactors and job creators. Quantitative Easing 1 (QE1) and QE2 had already successfully channeled funds through the system and filled corporate treasuries with low cost capital which is supporting the already fragile recovery. 

Others perceived the Fed move as a preparatory scenario for an another QE3-fielding the necessary signals to the market, keeping available liquidity for timely Bond releases.

Notwithstanding the above probable explanations, I think Mr. Bernanke and this Fed were engaged in a more extraordinary exercise and endorsing a more subtle stance that blindsided a myopic market, naturally  focused on its malaise. Mr. Geithner had already voiced his concerns that exogenous factors existed which also influenced US markets. Mr. Geithner minced few words when he warned the markets that European contagion was a real threat to a global recovery,  much greater than the immediate slowdown in the US economy. It was confirmed by all Central Banks that if Italy failed to refinance it might mark the collapse of the eurozone and generate a systemic collapse. The Fed was aware, as was the Treasury, that ECB and the EFSF resources would not suffice to cover the Italian and Spanish risk, if and when (within 2 years) they surfaced. There is only one player in the world that can assume the role of backstop required by the situation: enable the Eurozone to stay afloat in case of overwhelming risk, and  keep Germany, France and Italy from following into political and economic disarray, and from sending the euro through Hades, and many to Dollars and Gold,  SFr and maybe yen-but how much liquidity can they carry. The same can be said of gold: how much demand can it support.  European contagion would also dramatically undercut the engines that drive emerging market momentum which, at present, supports some of the global economic growth. Intrusion of the Fed in the short dates would have unnecessarily squeezed  Italian and Spanish offerings. It may just be that the US has saved the Italian offering.

The Fed's move was larger in scope and more daring in nature than meets the market eye. Perhaps, Frau Merkel can be more accommodating in tone when she reacts to the 'problems' in US markets and the challenges of the US Government.

US Sovereign Downgrade by S&P: Buffo!

On the evening of Friday, August 5, 2011, Standard and Poor’s, in an act of Bravura, downgraded United States Sovereign Debt rating to a AA+ from a AAA while reaffirming its A-1+ rating on US short term, notwithstanding their $2-trillion math-error! Bravura?  More Buffonata! than Bravura! This move had to some extent been discounted by global markets. Suffice to note the past week’s session drops in all major bourses. Those drops may also pre-empt the impending confusion and instability that will characterize the upcoming weeks' sessions on most security markets, especially from Asian and European markets which, opening after watching the announcement, should experience a tumble, but not a crumble.  

Todate, Moody’s and Fitch Rating have shown caution in this regard reserving their assessments for later.

The analysis by Mark Zandi of Moody's on fiscal sustainability,  tax reform and responsible compromise demonstrates the type of level headedness that is required by Credit Rating Agencies when they approach new paradigmatic scenarios, because de facto, the current US Debt situation invites paradigmatic shifts in methodology and optics.

Sovereign Balance Sheet is not a Corporate Balance Sheet. There are overwhelming incidences of political discretion that can neither be reduced to a quantitative measure nor can they be appreciated as stand-alone components for a measurement standard. The deficit cannot be isolated from the trade-off matrices that configure the US relationship to its broader sphere of influence within the domestic and  global political and economic network.   

Apart from a global audience whose appetite was partially satisfied by the Washington deal, the winners of the Washington tug-of-war will be investors. The basic premise that some investors will be precluded from future purchases is unrealistic. Most institutional players have portfolio criteria that permits purchases on any security rated a AAA to peers by at least one or two of the Big Three. Flight from US Treasuries is also very unlikely because there is no other safer investment haven in the world than the United States.

On the downgrade, markets will bid up the AA+ US Treasuries; many investors will pull out of equity markets leading to their decline resulting from the failure of corporate equities to compete with rising sovereign debt.  The US Dollar could appreciate for a time, as timely capital inflows into the US on purchases of US sovereigns dominate foreign exchange markets. At one point, given all things equal, markets will reach a state of equilibrium: the USD should subsequently  fall into a lethargy . How far down must the Dollar fall before the J-curve comes into play is anyone’s guess. US manufacturers are no longer very competitive on global markets. Marshall-Lerner conditions may no longer prevail in an orthodox manner- what previously worked and set precedents may no longer apply to current conditions.  Ultimately, a drop in the currency increases the existing deficits and dissembles interest for the de-facto guarantor of most of the world’s assets. Moreover,  core expenditures cuts may dramatically affect a large number of sectorial players in energy, financials, defense, health and transportation as well as state, municipalities and para-government agencies.

By 2012, unless deemed progress is made on the deficit front, markets may be confronted by another adverse assessment of the US Debt situation that could trigger another downward spiral and so on.

So returning to rational predicaments.
When is the Big Sell-Off.
How much has already been Shorted.
What is the option to a Big Sell-Off.

As with any rational and conceivable counterfactual scenario, the market must review the effects of the day-after.

Firstly, if a AA+ still attracts investors, then the S & P  Grid is substantively superfluous, because it does not deter investors, it merely panders a price peg.

Secondly, if it really considers US Sovereign Debt as relatively compromised in relation to other options (what similar options are there?), then S&P should be integrally considering a reassessment, if not a downgrade, of every major holder of US securities: reassessing the actuarial liability of every pension fund, the unit value of every mutual and the stability of every Bank in the world carrying US Treasuries especially the those of the UK, Canada and the Caribbeans, as well as the holdings of the Governments of China, Japan and Taiwan, since the integrity and liquidity of their respective financials are now compromised.

Thirdly, trading partners' current accounts may find themselves as compromised by the US deficit reduction plan as US domestic players. They, and their own nationals, may indeed have to envisage a weaker investment profile than anticipated in face of such a contagion as their own economic growth falters and begins staggering.   

Finally, the effect of contagion within the American political and administrative system is even more immediate. Municipal, state and other domestic secured borrowers will not only find their investments more expensive to finance, they may actually find themselves excluded from markets. The impact of the above is extremely onerous on regions and communities attempting to recover. It is even more onerous on the American people as households will be forced to pay more for their debt. What appeared as an enterprising improvement in household wealth in the last quarters may quite rapidly deteriorate into ephemera.

There appears to be no end to the downward spiral. The downgrade weakens the Dollar, and eventually adversely skews expectations on Dollar Assets, further defeating the Dollar Stability Paradigm. Why would anyone hold Dollar assets under such conditions.  It is somewhat irrational to advance a rational argument that impels an irrational decision. Theoretically, the world should dump dollars; but no coordinated action has been exercised yet. Is the premise false or are the components of the dilemma flawed. Probably a combination of both. As to the premise that the downgrade weakens the Dollar and the Stability Paradigm is weakened, there is some truth, but there is no  real dilemma since there is no credible option to the dollar, except for the esoteric: Gold, and that should experience an early surge next week, or short date moves to the Swiss Franc or Yen. If one buys into the Gold Niche, then the predicament is: should we not revert back to the Gold Standard.

Perhaps, the real issue is that no one cares about the one S & P evaluation in the case of US Debt because 'safe haven' should be given more value than the nature or size of the deficit. Or perhaps, as reality sets in, investors will realize that the US will continue refinancing its interest payments at a higher cost indefinitely, and the principal is far enough out that it will not affect their immediate results, and in turn will be itself refinanced. So enough for intergenerational considerations!Circuit theory  and modern monetary theory can certainly clarify the situation at hand and suggest reasonable solutions. We are de jure dealing with a perpetual money printing process.

As bond yields rise, equity markets sell-off,  and since interested liquidity is not abundant these days, the market promotes its own volatility, prefers the selloff to being hostage to an uncertain future 12 months down the line-the US debt-limit problem will resurface in 2012. One hears the snickers of a community of free-loaders and free-riders. In the end, one witnesses a run to les paradis artificiels of gold and similar glitters. Metals follow course and a manufacturing sector that had tolerated an adverse and unexplainable peak in prices, experiences once again a surge in commodity prices, a drop in demand -the combination of which dampens their recovery. Layoffs follow. Companies close and household wealth plummets. We are in the third phase of the Great Recession, or Phase One of the Great Collapse. For workers and their families, it is inconceivable that this happen in and to the United States.  

Did S&P cynically engage in a Marketing bravado of 'I was First' or 'We blew it last time, and we got hammered by the US Government-it's our turn now!!! '

If so, then it's ironic that Nemesis should be invoked in this farcical manner. Showmanship is not publicly responsible. To be sure, what the Rating Agency contends is that it is simply acting in accordance with its professional responsibility, intending Hayek and claiming unintended consequences  with respect to the outcomes in performing its mission.But markets have short memory spans; they were ready to crucify S&P a few years ago for negligence; now they'll take the free ride they offer.

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Debt-Limit Impasse and US Credit Rating: Nonsense per Beckett


The high probability that a political stalemate between a trying President Obama and a headless GOP would unleash an economic nightmare in the global financial system was unprecedented in American politics. To observe this staging with its original cast, from showmanship through the intrigues of gamesmanship only to end in a display of outright irresponsible brinkmanship was more like unraveling Kahn's absurd than thinking the unthinkable.  There was nothing tolerable being rehearsed on the stage in Washington.

For some, the Republican House had little to lose: they may have shattered the image once and for all of an already tarnished and staggering President Obama, if not out of the White House, most probably out of some future Majority. There is now, in hindsight, a conversation within the GOP depicting the emergence of a ‘Republican moment’ that will define the party and establish its future credentials. For others,  this supposedly tactical moment may have sealed the coffin to the GOP's own demise for the upcoming election.

Yet, the debt-limit impasse between a Presidential vision and the GOP counterproposal  led most pundits to rethink public ethos and try to figure out which of the parties was more irresponsible: President Obama in failing to appreciate the tactical whims of a political adversary  or the Republicans failing to appreciate the gravity of the demise bearing on the American economy , and the unwarranted burden of malaise and suffering being wrought on seniors, children, the sparsely employed and the unemployed.

The actors lost themselves in their mimes. Both parties-the White House and the House have forgotten the nature of their primary obligations.

Who stands to lose?

There are over 14M unemployed in the land, disposable personal income has decreased since 2007 with the exception of the 2009 anomaly, household wealth although rising, is slowing down, is also largely mitigated by a rise in values of financial assets that could as easily reverse their course and plummet family balance sheets overnight, and finally poverty thresholds are being surpassed daily with over 45.8M, or about 15%, of Americans on food stamps. To further taint this cautionary tale, there is no clearing in that bleak vision that signals an abetting storm; quite to the contrary, a piebald horizon of weak data and weakening indicators omens more the fury of a squall than a desired calm.

One daresay that the world was witnessing a burlesque rendition of Waiting for Godot. Certainly, Samuel Beckett could not have construed better and original script for a more consequential tragicomedy in two acts, than the Washingtonians did with such a routine episode of American Domestic Politics as the Debt-Limit debate. Note Beckett's Vladimir underscoring Washington's lack of public accountability

"Let us not waste our time in idle discourse! (Pause. Vehemently.) Let us do something, while we have the chance! It is not every day that we are needed. But at this place, at this moment of time, all mankind is us, whether we like it or not. Let us make the most of it, before it is too late!"

and with the same breath, note again Vladimir underscoring Washington's lack of political responsibility

"But that is not the question. Why are we here, that is the question. And we are blessed in this, that we happen to know the answer. Yes, in this immense confusion one thing alone is clear. We are waiting for God [ot to come]"

Classic Drama, with all the classical elements, written for Washington!

Yet, Beckett's characters in waiting resonate within the absurd; Washington's characters await generational inspirations for having lacked the day's resolve- again Vladimir

"To-morrow, when I wake, or think I do, what shall I say of to-day?"

It seems that, if anything is to be recognized, it is that the debt-limit dateline should have been a moot issue; the grotesque impact will and could come from the evaluation of US Treasuries by the Credit Rating Agencies, in particular the Big Three,whose own records during the last three years have been less than commendable. The same process that lacked discernment with  an infinitely less complex file back in 2007 will now determine the demise of a AAA sovereign. If the fate of future generations rests with the hubris of a community of analysts whose only consequent is a pricing label - that influences the cost of capital that should be ultimately tagged to the sovereign’s Treasury, then we are inviting a systemic disarray.

Yet, the US is still the most secure investment haven in the world and the latter feature will not be justly embedded in the credit rating evaluation.

The embarrassment cannot be undermined; the economic and financial costs to the US Government and the American people must not be underestimated.  The Rating Agencies should defer their assessments in order to fine-tune their methodologies, to refine their presumptions of what constitutes default risk, and to review the values that constitute and embed appropriate fiscal and monetary management of public finances in the 21st century.