Good Evening: The U.S. capital markets shuddered with a thought that many participants had never before considered — the credit worthiness of the sovereign entity known as the United States of America . This unheard of discussion started with a small downtick in the credit outlook for Great Britain , but, as with any form of contagion, the sovereign credit pathogen hopped aboard a transatlantic flight and soon landed in New York . PIMCO’s Bill Gross only added to these concerns about our nation’s fiscal health when he opined that the U.S. would eventually lose its AAA status. By day’s end, stocks, bonds, commodities, and the U.S. dollar were all significantly lower. Investors are finally waking up to the fact that trying to bail out everything may have large consequences.
Today’s economic data — jobless claims, leading indicators, and the Philly Fed survey — were all within consensus estimates. Only jobless claims had much of an impact, as a new record high in continuing claims hit our stock index futures prior to the opening bell. Those futures were already under some pressure after S&P announced that it was changing the credit outlook for the AAA-rated U.K. to “negative” from “stable”(see below). The news cost the Sterling a shilling or two and British stocks were pounded. Back across the pond, U.S. stocks opened lower in sympathy, but the U.S. dollar and Treasurys initially benefited from the U.K.’s plight.
Our relative outperformance lasted only until market participants started wondering if such a fate could some day befall Uncle Sam. Stocks kept edging lower until the major averages were down 2% or more by lunchtime, but it was the action in the bond and currency markets that created a mid day stir. First, the Fed bought fewer Treasurys today than traders were expecting. Second, a huge refunding was announced for next week that reminded everyone of how much supply looms on the horizon. Treasurys and the dollar fell together and soon found the footing even more slippery when PIMCO’s Bill Gross had the following to say:
“The markets are beginning to anticipate the possibility of” a downgrade to the U.S.’s top rating, though “it’s certainly nothing that’s going to happen overnight…Both the U.K. and the U.S. have prospective deficits of 10 percent annually as far as the eye can see,” Gross said. “At some point over the next several years” the debt of each “may approach 100 percent of GDP, which is a level at which country downgrades tend to occur,” he said. (source: Bloomberg.com)
I’m a little surprised that Mr. Gross finally voiced in public what many have thought in private (or have been saying more subtly), but now it’s out there for all to contemplate. Let me be clear when I say that we live in a great country, one that will NOT have trouble discharging its dollar-denominated debts. We can decide to reduce spending, raise taxes, enhance our productivity, or, when all else fails, invoke Mr. Bernanke’s helicopter concept. What the “full faith and credit of the United States of America” does not guarantee, however, is that the dollars received will be worth tomorrow what they are worth today. A falling currency, rising interest rates, and ascending precious metals prices would be the market response to this outcome. We saw a taste of this today.
I hope Mr. Gross was just trying to call the attention to this problem, and I hope our leaders in Washington were listening. Our capital markets buckled when they heard this message, which should be statement enough for both parties to take it seriously. If any readers have wondered why I’ve been whining in print about all the printing of money and excess spending in Washington, today’s market action offers a simple and elegant reason why. Past a point (and we’re not there yet) it’s dangerous.
After descending 3% or more, the major averages made a small comeback before the bell rang. The losses ranged from the Dow’s 1.5% to almost 4% for the Dow Transports. Treasurys were smacked and the yield curve noticeably steepened. 10 year and 30 year yields rose by more than 15 bps each. The dollar gave up its early gains and headed south to the tune of 1% (see below). The diving greenback should have helped commodities, but they cowered in the face of higher interest rates and weaker stock prices. Only the precious metals showed any resilience today as the CRB index declined 1%.
The financial crisis cum bear market of 2007-2009 has brought with it a vast array of uncertainties. About the only two things we all know for sure are that 1) the machinery behind private credit creation (a.k.a. the shadow banking system) has broken down in the U.S, and that 2) the U.S. government has stepped in with multiple trillions of dollars to help restart it. Hopes that the myriad forms of interventional rescue were going to be a decent substitute for decisions banks once made privately have been plain to see since March. With the arrival of spring, stocks have blossomed, credit spreads have narrowed, and the first green shoots of confidence have returned. It’s been a welcome sight to see the markets recover, but what about the economy?
The answer is that it is very hard to measure just how Uncle Sam’s attempts to become a banker are faring. Too much credit, too little of it, and the happy median of the Goldilocks era would each require different policy adjustments, but who can measure the difference between the amount of private credit withdrawn and the amount of public credit being created? The Credit Suisse fixed income team in London tackles this very subject in its latest “Market Focus: Long Shadows” (see above). CS attempts to define these various monetary relationships (simple money supply is a shadow of its former self and only tells part of the story) and then measure the changes in them over time.
It’s a long and fascinating piece, if you’re a money and credit junky like me. If you aren’t, let’s just jump to the end and say that the CS team believes the U.S. policy response has been admirable to date. They believe that of the trillions of credit withdrawn, Uncle Sam has stepped in to provide just less than a matching amount. I do have questions about their methodology (they rely on repo. haircuts as a proxy for credit creation in the shadow world), but I think their work is an interesting way to think of credit flows outside the traditional banking system. If Credit Suisse continues to track these figures and their changes, I’ll be curious to see what impact the Fed’s expanded TALF program has on their data. What effects this government-sponsored lending has on the markets and our economy is another matter entirely. As we saw with today’s gyrations in our capital markets, these policies will — even if they “work” — have effects that are far-reaching and consequences that may or may not be the ones our leaders originally had in mind..
— Jack McHugh
U.S. Stocks Tumble on Jobless Claims, U.K. Debt-Rating Concern
U.K. May Lose AAA Rating at S&P as Finances Weaken
Pimco’s Gross Says U.S. ‘Eventually’ Will Lose AAA
Dollar Decline Takes on ‘Life of Its Own,’ RBS Says
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