Monday, August 8, 2011

Bigger May Be Different

. Monday, August 8, 2011

It is the irony of the downgrade,” says Lou Crandall at Wrightson Icap. “What do you do if the US is downgraded? The answer is, buy more Treasuries.” Two and three-year Treasuries hit record lows of .23 and .48 percent. 10-year notes fell to 2.33%, their lowest yield since January 2009.

Do we really close this loop by asserting that the downgrade caused the sell off?


Emmanuel said...

We must look at the larger context.

Read it this way: the S&P downgrade hinged on diminished future prospects for the US economy impairing its previously unquestioned ability to honour its obligations. If you read the downgrade statement, they mention the BEA's downward revisions to GDP and the "sluggish pace" of recovery at length.

Accordingly, the stock market plunge was a response to this understanding--further acknowledgement that the US economy was in very poor shape--more than anything else.

So you get consistency: sovereign bond yields plunge, while stocks do the same as expectations of another recession rise.

Thomas Oatley said...

Their decision to downgrade had nothing to do with future growth prospects and everything to do with the ability of our elected officials to make the decisions required to stabilize the fiscal position.

"We lowered our long-term rating on the U.S. because we believe that the prolonged controversy over raising the statutory debt ceiling and the related fiscal policy debate indicate that further near-term progress containing the growth in public spending, especially on entitlements, or on reaching an agreement on raising revenues is less likely than we previously assumed and will remain a contentious and fitful process. We also believe that the fiscal consolidation plan that Congress and the Administration agreed to this week falls short of the amount that we believe is necessary to stabilize the general government debt burden by the middle of the decade.

And I don't disagree at all with your assertion that the poor short-term growth prospects is driving the sell off in equity markets, especially in Asia. And I have no doubt but that the looming defaults in Italy and Spain are adding to the gloom. But none of this has anything whatsoever to do with the S&P decision last Friday.

Perhaps the media coverage in London is less pathetic than it is here. Because here, one would never know that the EU is in the midst of a rather dramatic sovereign debt crisis of the kind that happens when market participants actually begin to question whether a government has the capacity to service its debt.

Emmanuel said...

Not so sure about that. If you read farther down the statement, you come to this:

Our revised scenarios also take into account the significant negative revisions to historical GDP data that the Bureau of Economic Analysis announced on July 29. From our perspective, the effect of these revisions underscores two related points when evaluating the likely debt trajectory of the U.S. government. First, the revisions show that the recent recession was deeper than previously assumed, so the GDP this year is lower than previously thought in both nominal and real terms. Consequently, the debt burden is slightly higher. Second, the revised data highlight the sub-par path of the current economic recovery when compared with rebounds following previous post-war recessions. We believe the sluggish pace of the current economic recovery could be consistent with the experiences of countries that have had financial crises in which the slow process of debt deleveraging in the private sector leads to a persistent drag on demand. As a result, our downside case scenario assumes relatively modest real trend GDP growth of 2.5% and inflation of near 1.5% annually going forward.

If you read the BEA release referred to, it's quite bleak in noting that real GDP has fallen Stateside from 2007 to 2010:

For 2007-2010, real GDP decreased at an average annual rate of 0.3 percent; in the previously published estimates, real GDP had increased at an average annual rate of less than 0.1 percent.

From the fourth quarter of 2007 to the first quarter of 2011, real GDP decreased at an average annual rate of 0.2 percent; in the previously published estimates, real GDP had increased at an average annual rate of 0.2 percent.

As for news of European finances, most of the folks in England have fixed their attention on riots spreading across the nation at the moment. I suppose physical safety trumps that.

Bigger May Be Different




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