Thoughts On The Downgrade, Geithner, And The Next Big Move In Markets

1. S&P Downgrade- We can all talk until the cows come home regarding whether or not S&P was justified for downgrading the US to AA+.  To me, the major points of a credit rating are “willingness” and “ability” to pay ones debt.  Once again, assuming a debt ceiling type restriction is not in place, the US is a sovereign currency issuer and has an infinite ability to pay it’s debts.

When interviewed on Friday, Warren Buffet echoed this sentiment, “…”Think about it. The U.S., to my knowledge owes no money in currency other than the U.S. dollar, which it can print at will. Now if you’re talking about inflation, that’s a different question.”

In my opinion the key conclusion is that the bond markets have shown that they understand the difference between a sovereign currency issuer (ex: USA) and a currency user (ex: Greece)

2. The Next Big Move- It’s safe to say that sentiment among investors and the Street has shifted dramatically over the past few weeks.  It wasn’t so long ago that I mentioned that the most BULLISH primary dealer economist forecasted the 10yr UST finishing 2011 at ~3.20%.  The most bearish forecast being closer to 4.25%.  Please consider some of the recent comments from the street this weekend:

Goldman-  “…We have lowered our growth forecast further and now expect real GDP to increase just 2%-2.5% through 2012.  Since this pace is just below the US economy’s potential, we now expect unemployment rate to be at 9.25% by the end of 2012….We now see a 1 in 3 risk of a renewed recession…We expect the Fed to extend the “extended period” language…We also expect them to shift the maturity of the reinvestment to longer maturities…”  

-CRT – “…We are now inclined to a hold a core long in USTs.  It’s not so much about price appreciation, but rather we expect rates to be low for a long while and are especially concerned with double dip potential…”

-RBS-  “…we see reinforcement for the development of a new, lower rate range for the 10yr treasury”

-Deutsche Bank- “If the Fed could ease…10’s would trade to 2.05%…”

Barclays-  “We see few changes until Jackson Hole when the Fed will likely begin the process for “Operation Twist”

Morgan Stanley- Friday they made sure to tell us all to NOT be short duration and informed us of their econometric models now suggesting a further decline to 2.10% on 10s.

Given that the bond rally has been so strong, I would say that I am no longer strongly overweight longer bonds here, but would echo the sentiment by CRT above.  As with the previous episode, the actual buying of securities could be met with rising yields.

With the recent events, I would be pretty surprised if the Fed doesn’t intervene in a very big way.  They have gone too far to throw in the towel now.  Public scrutiny will subside if/when the broader public starts to see increased deterioration in the economy.  Hence, I am now a buyer of risk.  Not because I think QE3 can do anything that QE 1&2 failed to do, but because at least initially it will lead to a rally.

3.  Geithner announces his return- The return of Tim Geithner to the Treasury secretary post has been met by much criticism in political and economic circles.  I believe it’s ridiculous to think that Geithner is a major cause of problems.  While it’s no surprise that he’s being made out to be a scapegoat, the reality is that the public vastly overestimates the power of the Government.  The man went into office in early 2009, and people are blaming him for housing, derivatives and other major problems.  Could he have had greater influence during his tenure at NY Fed?  Sure, there is plenty of blame to go around, including him.  Citing him as a major culprit of our current situation?  Pure silliness.

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