Tuesday, August 9, 2011

US rating downgrade

Late Friday rating agency S&P downgraded the U.S.’s long-term credit rating a notch to AA+, ending a 70-year tradition. It also retained a negative outlook on the debt rating, suggesting a possibility of a further downgrade “within the next two years” unless more progress is made on deficit reduction. S&P gave a thumbs-down to both the recent deficit-reduction plan and the increasingly unpredictable and ineffective political process. As a result the equity markets are poised to open lower following last week's decline.

US Treasuries have risen reflecting safe-haven buying and the fact that the chance of a rating cut was priced in following S&P’s elevated warning in mid-July and rumours of an announcement on Friday afternoon. As well, two other rating agencies - Moody’s and Fitch - have recently affirmed the U.S.’s triple-A rating, for now. I should point out that the S&P’s credibility was dented when its initial report to the White House (on Friday) contained a $2 trillion error in deficit projections.

 Despite losing its mint rating, the U.S. is extremely unlikely to default, given its enormous wealth and substantial tax base.  Optimistically, the downgrade could spur the two warring political parties to work more cooperatively for the good of the nation. The new Congressional “supercommittee” will now be pressured to find more than $1.5 trillion in savings to preclude the possibility of further downgrades and help the U.S. earn back its pristine rating.  That said, in the longer-term the move could put mild upward pressure on the government’s borrowing costs, though Japan’s and Canada’s experience with downgrades suggests any increase would be minimal.

Downgrade impact on Canada… Our Sherry Cooper noted the following over the weekend: In this environment, commodity prices likely remain soft and the Canadian dollar is vulnerable and extremely volatile.  That, in itself, is not bad for the Canadian economy.  However, our stock market, like all others, will feel the short term affects due to its close ties to the US economy. Messieurs Harper, Flaherty and Carney can only counsel Canadians to remain calm, reassert that the domestic fundamentals of our economy are good.

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