Unimpressed with U.S. deficit reduction plans, S&P delivers on its warning.
You are probably asking: What happened this week? What is Klein Financial Advisors planning to do? And what, if anything do I need to do? The fight or flight animal in all of us wants to react. Remember that panic is not a strategy.
Unprecedented and unsettling. Standard & Poor’s issued a historic downgrade of U.S. debt on August 5, sensibly waiting until the market week had concluded to send a shock wave toward global investors. It reduced America’s long-term debt rating – which had been AAA since 1941 – to AA+.
S&P felt Congress did too little too late. The credit rating agency had threatened the downgrade if Congress passed any deficit reduction plan smaller than $4 trillion in scope. The Budget Control Act of 2011 “falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics,” an S&P statement noted. It also retained its “negative” credit outlook on the U.S.
S&P is also skeptical that the federal government can collect more money from taxpayers. Its analysts do not think the Bush-era tax cuts will sunset at the end of 2012 “because the majority of Republicans in Congress continue to resist any measure that would raise revenues.”
The other ratings agencies – Fitch and Moody’s have not downgraded the United States. Fitch has said a downgrade remains a possibility. Moody’s “thought a downgrade would be premature given that they [Congress] have come up with a plan for deficit reduction. Analysts are monitoring to see if lawmakers are able to agree on $1.5 trillion in further cuts.
China’s comments. The world’s largest holder of U.S. debt issued a withering critique of Congress through Xinhua, its official news agency. The state commentary stressed that the U.S. has a “debt addiction” only curable via major cuts to defense spending and entitlement programs. It also said that the option of a “new, stable and secured global reserve currency” should be explored.
The Treasury’s claim.Friday evening, the Treasury argued that S&P’s analysis contained an accounting error that unnecessarily added $2 trillion to its projection of U.S. debt. S&P admitted the error but stuck with the downgrade.
So what happens now?The markets that were open over the weekend, including Israel, have been volatile and nervous. The Asian markets that opened this morning with declines. The initial global response aside, analysts are divided as to what the short-term impact might be for the American economy. Could it cripple the recovery, or just prove inconvenient to it?
Demand was big for Treasury notes even before the threatened downgrade and Treasuries still symbolize comparative safety to institutional investors, so an August selloff might be short-lived. If this turns out to be the case, the effect on interest rates might be less significant than feared.
Could the Fed launch QE3*?The possibility exists, particularly if foreign investors ditch dollar assets. The Fed’s Open Market Committee will make an announcement on August 9, and few analysts expect another wave of bond buying – but it is an option.
When might the U.S. recapture its AAA rating?It might take years for that to happen. S&P has cited political gridlock on Capitol Hill as a major reason for the downgrade, and it doesn’t see that going away in upcoming months. On top of that, the U.S. economy expanded just 1.3% in the first half of 2011 - about half the pace needed to dispel the lingering effects of recession.
Wall Street might sail through this.Does that sound far-fetched? Look at some historical examples. S&P downgraded Canada’s AAA credit rating in the spring of 1993, yet Canadian stocks gained 15% in 1994 and our northern neighbor had its AAA rating back by 1997. Moody’s Investors Service downgraded Japan in November 1998 and its stock market advanced more than 25% in the next 12 months. Italy, Canada, Ireland, Japan, Belgium and Spain have all suffered S&P downgrades from AAA, and most of these cuts had little sustained impact on government bond yields.
What’s our outlook?Whatever happens in Congress, in Europe and in the daily market activity, Klein Financial Advisors will act prudently with your long term financial security in mind. Still feeling jittery? This may be a good time to revisit your risk profile – your ability, need and willingness to accept risk – and consider updating your investment policy.
Don’t hesitate to call to discuss your personal financial security.
And yes…stay confident and stay the course….especially on days like this.