20 April 2011
Ratings agencies have an uncanny knack of turning up at morgues and pronouncing the death of the deceased, so it should have been no surprise that Standard & Poor's did the 'unthinkable' and downgraded the United States' long-term outlook to negative from stable.
Of course, they were careful to reiterate that the United States gold-plated 'AAA/A-1+' rating was intact, yet global markets - already overbought and creaking under the collective weight of speculation - collapsed at least on the day.
The possibility of the U.S. losing its triple-A sovereign credit rating is not a new concept and has simmered on the back burner for years, notes Bank of Montreal in a report.
"Based on traditional metrics employed by credit ratings agencies, and a reasonable economic scenario, it appears inevitable that the underlying creditworthiness of the U.S. will slip below AAA status in the years ahead," says Douglas Porter, deputy chief economist at the bank. "Whether that triggers an actual downgrade is open for debate, but financial markets will increasingly factor in the underlying reality in any event."
U.S. creditworthiness has been in doubt for some time as budget deficits ran up and debt to GDP ratio have risen over the medium term. The U.S. fiscal position deteriorated during the recession and especially after the government took on commitments of entities such as Fannie Mae and Freddie Mac. Just over a year ago, S&P suggested that "Fannie and Freddie could cause the U.S. to lose its sterling AAA rating if the government were forced to come to their rescue".
Bloomberg estimates that the U.S. government and the Federal Reserve have "spent, lent or committed US$12.8-trillion", or more than 90% of GDP, to ease the recession and credit crisis.
Underneath this wave is the rapidly rising tide of social security and health care costs. With such underlying weaknesses gnawing at its economic core, the only reason why the United States has hold on to its AAA rating is its political might.
What does it mean for the Middle East?
Given that most Gulf states are pegged to the U.S. dollar, there are serious repercussions for the region to the events taking place in the halls of the Federal Reserve, Capitol Hill and the White House.
Interest Rates: With many Gulf states on the verge of experiencing inflation, there have been few signals from Federal Reserves' Ben Bernanke that he will raise interest rates anytime soon. Low interests in the US at the time of rising inflation in the Gulf would feel like 2007 all over again for the authorities.
Many countries in the region have earmarked domestic spending in the year and they will be reluctant to curb that spending on political grounds, leading to inflation which they will have no monetary tool to control.
Analysts also expect to see more punitive market reactions to a political deadlock in Washington over the budget, including a weaker US dollar, which would further fan the flames of inflation.
World Trade: Business sentiment in the U.S., already fragile, could suffer further as political bickering in the U.S. continues. For all its problems, the United States remains the largest economy in the world and if the country lurches once again towards a recession, the rest of the global economy, including the Middle East, will go down with it too.
Oil Prices: A U.S. economy in reverse gear will also impact oil prices. Goldman Sachs expects a pullback (Goldman Sachs Gets Bearish On Oil http://www.zawya.com/story.cfm/sidZAWYA20110417053013), and has advised clients to sell commodities and developed markets stocks and dive into emerging markets over the summer.
A crash or collapse in oil prices could hurt Gulf states and other oil-exporting Middle East states, especially as they have embarked on unrest-dousing public spending programmes and need high oil prices to remain in the black this fiscal year (Opec Breakeven Oil Prices Are Rising At Worrying Levels)
Market Volatility: Gulf states have ignored the bull runs in global markets, but have eagerly embraced the volatility. After a prolonged rally in global equity markets, analysts are expecting a cooling off period, and expect the regional markets to mirror that sentiment.
"Market tolerance for the escalating debt would run thin if a credible and transparent plan wasn't in place by 2013 - after the next U.S. presidential election, in which this issue would be a key focus," says TD Bank, which has a major franchise in the United States. "However, the negative watch by S&P looks to have pushed forward this timeline, or at least heightened the market scrutiny on policymakers."
QE3?: We are already at the fag end of the second gravy train that is quantitative easing, initiated by the US Federal Reserve. Q1 bailed out the financial institutions, and Q2 had a much broader scope and it was expected to end by June.
Fed officials have been divided whether to extend the QE2 programme or exit, but S&P's latest move may have ended that debate. Societe Generale's Rudy Narvas says that while the downgrade does little to alter his near-term economic outlook, it could have implications for 2012 and beyond.
"The S&P announcement could serve as a wake-up call for Washington and increase the chances that a compromise can actually be reached this year. If so, the fiscal drag on the economy in 2012-2013 would be greater than we had assumed, and the Fed's exit could be delayed. Ironically, this means that the S&P move could actually prove supportive for the Treasury market in the medium-term. The dollar would be pressured lower in this scenario."
Hard Landing: A QE3, or Q2-plus means the continued availability of cheap credit and more overheating of global economies, higher oil prices, and perhaps a harder landing for emerging economies.
The IMF admonished emerging countries on April 18 for not taking enough measures to help cool down their scorching economies.
"In some emerging economies, credit booms and overheating threaten eventual hard landings. In emerging economies, the challenge is to avoid overheating in the face of closing output gaps and higher capital flows," the IMF said in a note during the G20 summit.
The Middle East's trade flows with eastern economies have soared over recent years and any major setbacks in those economies could have a far direct and immediate impact than the weaknesses in the US economy.
With the kind of year Middle East governments are having, they will be paying more attention to their domestic problems rather than foreign ones. But they shouldn't, even in their most distracted state, be out of synch with the inner workings of the Washington political and economic machinery.
© alifarabia.com 2011
Ratings agencies have an uncanny knack of turning up at morgues and pronouncing the death of the deceased, so it should have been no surprise that Standard & Poor's did the 'unthinkable' and downgraded the United States' long-term outlook to negative from stable.
Of course, they were careful to reiterate that the United States gold-plated 'AAA/A-1+' rating was intact, yet global markets - already overbought and creaking under the collective weight of speculation - collapsed at least on the day.
The possibility of the U.S. losing its triple-A sovereign credit rating is not a new concept and has simmered on the back burner for years, notes Bank of Montreal in a report.
"Based on traditional metrics employed by credit ratings agencies, and a reasonable economic scenario, it appears inevitable that the underlying creditworthiness of the U.S. will slip below AAA status in the years ahead," says Douglas Porter, deputy chief economist at the bank. "Whether that triggers an actual downgrade is open for debate, but financial markets will increasingly factor in the underlying reality in any event."
U.S. creditworthiness has been in doubt for some time as budget deficits ran up and debt to GDP ratio have risen over the medium term. The U.S. fiscal position deteriorated during the recession and especially after the government took on commitments of entities such as Fannie Mae and Freddie Mac. Just over a year ago, S&P suggested that "Fannie and Freddie could cause the U.S. to lose its sterling AAA rating if the government were forced to come to their rescue".
Bloomberg estimates that the U.S. government and the Federal Reserve have "spent, lent or committed US$12.8-trillion", or more than 90% of GDP, to ease the recession and credit crisis.
Underneath this wave is the rapidly rising tide of social security and health care costs. With such underlying weaknesses gnawing at its economic core, the only reason why the United States has hold on to its AAA rating is its political might.
What does it mean for the Middle East?
Given that most Gulf states are pegged to the U.S. dollar, there are serious repercussions for the region to the events taking place in the halls of the Federal Reserve, Capitol Hill and the White House.
Interest Rates: With many Gulf states on the verge of experiencing inflation, there have been few signals from Federal Reserves' Ben Bernanke that he will raise interest rates anytime soon. Low interests in the US at the time of rising inflation in the Gulf would feel like 2007 all over again for the authorities.
Many countries in the region have earmarked domestic spending in the year and they will be reluctant to curb that spending on political grounds, leading to inflation which they will have no monetary tool to control.
Analysts also expect to see more punitive market reactions to a political deadlock in Washington over the budget, including a weaker US dollar, which would further fan the flames of inflation.
World Trade: Business sentiment in the U.S., already fragile, could suffer further as political bickering in the U.S. continues. For all its problems, the United States remains the largest economy in the world and if the country lurches once again towards a recession, the rest of the global economy, including the Middle East, will go down with it too.
Oil Prices: A U.S. economy in reverse gear will also impact oil prices. Goldman Sachs expects a pullback (Goldman Sachs Gets Bearish On Oil http://www.zawya.com/story.cfm/sidZAWYA20110417053013), and has advised clients to sell commodities and developed markets stocks and dive into emerging markets over the summer.
A crash or collapse in oil prices could hurt Gulf states and other oil-exporting Middle East states, especially as they have embarked on unrest-dousing public spending programmes and need high oil prices to remain in the black this fiscal year (Opec Breakeven Oil Prices Are Rising At Worrying Levels)
Market Volatility: Gulf states have ignored the bull runs in global markets, but have eagerly embraced the volatility. After a prolonged rally in global equity markets, analysts are expecting a cooling off period, and expect the regional markets to mirror that sentiment.
"Market tolerance for the escalating debt would run thin if a credible and transparent plan wasn't in place by 2013 - after the next U.S. presidential election, in which this issue would be a key focus," says TD Bank, which has a major franchise in the United States. "However, the negative watch by S&P looks to have pushed forward this timeline, or at least heightened the market scrutiny on policymakers."
QE3?: We are already at the fag end of the second gravy train that is quantitative easing, initiated by the US Federal Reserve. Q1 bailed out the financial institutions, and Q2 had a much broader scope and it was expected to end by June.
Fed officials have been divided whether to extend the QE2 programme or exit, but S&P's latest move may have ended that debate. Societe Generale's Rudy Narvas says that while the downgrade does little to alter his near-term economic outlook, it could have implications for 2012 and beyond.
"The S&P announcement could serve as a wake-up call for Washington and increase the chances that a compromise can actually be reached this year. If so, the fiscal drag on the economy in 2012-2013 would be greater than we had assumed, and the Fed's exit could be delayed. Ironically, this means that the S&P move could actually prove supportive for the Treasury market in the medium-term. The dollar would be pressured lower in this scenario."
Hard Landing: A QE3, or Q2-plus means the continued availability of cheap credit and more overheating of global economies, higher oil prices, and perhaps a harder landing for emerging economies.
The IMF admonished emerging countries on April 18 for not taking enough measures to help cool down their scorching economies.
"In some emerging economies, credit booms and overheating threaten eventual hard landings. In emerging economies, the challenge is to avoid overheating in the face of closing output gaps and higher capital flows," the IMF said in a note during the G20 summit.
The Middle East's trade flows with eastern economies have soared over recent years and any major setbacks in those economies could have a far direct and immediate impact than the weaknesses in the US economy.
With the kind of year Middle East governments are having, they will be paying more attention to their domestic problems rather than foreign ones. But they shouldn't, even in their most distracted state, be out of synch with the inner workings of the Washington political and economic machinery.
© alifarabia.com 2011
