One of the first things investors learn after “buy low and sell high” is that markets hate uncertainty.
A downgrade of the sovereign debt of the United States of America creates a profoundly uncertain condition.
More than anything, we have never experienced it before.
While we can look to other economies that have endured downgrades, the US, as home to the world’s reserve currency, is different. But, we are not sure just how different because we’ve never done this before.
I’ve been reading all weekend and am feeling a little punch-drunk from so many major stories, events and analytical reports.
- Jean-Claude Trichet heads the European Central Bank (ECB) and has pledged to “actively implement” bond buying to shore-up and limit the contagion of Italian and Spanish debt. This “lender of last resort” is a new role for the ECB. It is seen as a very risky, “shock-and-awe” effort. Many fear it will be a type of Quantitative Easing that will risk meaningful inflation.
- The US downgrade has been widely expected and therefore, I thought, priced in to current market levels. I was wrong. Dow Jones Industrial Futures were down around 240 points and Asia is down over 2%. (Real Time: CNBC's Markets Page) The reaction in the bond markets, however, has been starkly different. Yields on US Treasury bonds are actually down this morningas investors continue to seek a safe haven. This reaction to the S&P downgrade is counterintuitive, but that’s the world we’re living in.
- The US political deal to raise the debt ceiling but promise to slow the rate at which we careen deeper into debt is a partial solution that leaves a multitude of questions unanswered – not the least of which is any specific prescription for spending on Social Security and Medicare. This Congressional debate will continue as bitterly as ever and will have deadlines that, if missed, will cause draconian consequences. Look for more market-jarring ugliness.
- The dollar is falling. (Real Time: CNBC's Currencies Page)
- The interest rate on the 10 year Treasury Note is 2.47%.
- Employment data were mildly positive but insufficient to remedy the 9% + unemployment rate at any point in the foreseeable future.
- The Fed will not increase collateral requirements because of the downgrade and will continue to finance treasury and other positions as before.
From my perch, the week ahead appears to hold more unpleasantness and may be similar to last week. I think the Fed would be well advised to sit tight for a while (interest rates have moved much lower on their own). Oil is fallingwhich will help the average consumer at the pump and for the upcoming heating season. Interest rates are as low as they have been at almost any time in history. Corporate balance sheets are strong and dividends are attractive.
Though I continue to believe that housing prices will move lower, I’m beginning to see tentative elements of stabilization. Nothing portends a swift or easy recovery in my judgment. But the elements are coalescing.