How odd that the musings of a rating agency about the possible outcome of what is fundamentally a political debate, in what passes for a functioning and wealthy democracy, should be the catalyst that sets hands wringing – and fingers on those wringing hands grazing the sell button.
After all, Standard & Poor’s has had such a terrific record in identifying potential credit risks in recent years – that it is a wonder folks don’t buy on their negative utterances. Has anyone in the financial markets actually been unaware that the U.S. is underwater both publicly, as well as privately?
That gratuitous swipe at the raters having been dispatched, let’s remember that the equities markets have, together with commodities, been on a liquidity fuelled high for months. Global equities had already taken a dive today, before the A&P announcement, and the equities and commodities complexes have – for months – risen to levels far outstripping the performance of developed world’s real economies – either actual, or realistically anticipated.
Any exogenous influence that disturbs the markets’ psychedelic trip through “unconventional” monetary policy-land is sure to be a “bummer” – and justifiably so.
The markets have stalled and will continue to be challenged:
(i) because of enormously valid credit concerns about the Eurozone which, as a “going concern,” is in far greater jeopardy than the U.S. will ever be;
(ii) because, despite the unprecedented monetary and fiscal support from developed world governments, the recovery is decidedly unimpressive in the U.S., Japan and Europe – with the sole exception of multi-nationals’ earnings that are now facing margin challenges;
(iii) because the debt and deficits of developed-world governments is merely the easier to understand part of the massive debt overhang in those economies, much if which is in the consumer and real assets sector – creating sustained downward pressure; and
(iv) because whatever liquidity-driven inflation there is in the commodities complex, it is unsustainable and cannot and will not be translated into wage inflation (wages here continue to decline on a real basis), and that inflation will end with the withdrawal of the monetary intervention – assuming it is withdrawn.
But all that merely brings us to the real issue: The markets have, since last fall, been substantially disrupted and interests misaligned by QE2 and ZIRP and the sugar coating is melting off the quantitative candy as the Fed indicates that it is serious about June.
We see very interesting signs that demand on the long end is actually STRONGER than people (including one very prominent bond fund manager) are expecting and that 10 and 30 year yields have widened only slightly this morning (and the 7 year – arguably off the NY Fed’s shopping list – although one can’t be sure today – is rallying) despite the credit hysteria that is hitting the equity markets.
Let’s face it….if the credit of, and creditors’ interest in lending to, the U.S. is in mortal jeopardy, the credit markets aren’t showing it and the world would have far bigger problems than merely the state of the U.S. balance sheet. Look also to the current level of Fed Funds. The Fed is nearing the point at which the zero bound is looming for real – money is so cheap that banks are practically willing to pay others to hold onto it for them – and there is no collateral remaining out there for the Fed to buy or lend against now that it has monetized everything the QE2 vacuum has been able to suck up (maybe they actually will start buying excess houses as some, not us, have suggested).
No, the equity markets’ jitters these past several weeks are a preview of the big act to follow – the pulling of the feeding tube by the Fed and the (we think realistic) fears for the “patient” when forced to move from a liquid to a solid money diet. There is a reason that the tune changed from deflationary worries to inflationary ones over the past six months, and that reason – if policy makers are to be believed – is about to be eliminated.