Monday, April 18, 2011

S&P cuts US debt outlook to negative

Washington’s deficit reduction debate came to Wall Street on Monday, after the Standard & Poor’s rating firm lowered the outlook for the United States to negative, saying there was a risk that lawmakers might not reach agreement on how to address the country’s fiscal issues.

Indexes fell sharply as the S.&P. revision pushed the federal deficit problems out of the political arena and into the financial one.

Many analysts were surprised by the market response to the revision, which cut the long-term United States debt rating to negative from stable. The S.&P. also affirmed the government’s AAA rating.

“The idea that the US public finances are on an unsustainable trajectory is hardly new news,” economists from Capital Economics said in a research note. “Indeed, we warned that the US might be downgraded, or at least put on negative watch, as far back as nearly two years ago.”

Analysts said the upside of the announcement was that it could spur the administration and lawmakers to find a way to reduced the nearly $1.5 trillion budget deficit.

Steven Blitz, a senior economist for ITG Investment Research, said that the “S.&P. and all the rating agencies are still under a lot of pressure to reform and this action could help them by helping the White House scare the Republicans to engage in responsible political negotiation to reach some reasonable deal on deficit reduction and raise the debt ceiling rather than have the talks take on the aura of a hostage negotiation.”

Mr. Blitz said the revision involved a ratings change that could occur several years from now, but the timing of the release had political aspect, much like the heightened terror alerts during President George W. Bush’s re-election campaign..

Stanley Nabi, chief strategist at Silvercrest Asset Management Group, said the policy makers and lawmakers should “realize there is a very serious problem, and you are going to see more consideration on how to rein in expenditures.”

For their part, administration officials played down the revision while reiterating Washington’s determination to act. Treasury officials “believe S.&P.’s negative outlook underestimates the ability of America’s leaders to come together to address the difficult fiscal challenges facing the nation,” an assistant secretary for financial markets, Mary J. Miller, said in a statement.

President Obama has initiated a bipartisan process that will help make progress on restoring fiscal responsibility, the statement said.

“I think this is fundamentally S.&.P.’s making a political judgment,” said Austan Goolsbee, chairman of President Obama’s Council of Economic Advisers, in an interview with Bloomberg TV news, pointed out that President Obama in a recent speech had said that there would be actions taken to promote fiscal responsibility. “I don’t think that the S&P’s political judgment is right.”

Both President Obama and Republican lawmakers have suggested plans to cut the federal deficit by at least $4 trillion over the next 10 to 12 years, but by different methods. And Mr. Obama plans to take his message on the road this week, traveling to the West Coast to promote his plan, which combines spending cuts and revenue increases.

The Republican blueprint written by Representative Paul D. Ryan, the Wisconsin Republican who leads the Budget Committee, includes cutting non-defense spending, and a politically charged proposal to fundamentally reconfigure Medicare.

While the S.&P. said the proposals were a good starting point for negotiations, “we see the path to agreement as challenging because the gap between the parties remains wide.”

“We believe there is a significant risk that Congressional negotiations could result in no agreement on a medium-term fiscal strategy until after the fall 2012 Congressional and presidential elections,” the statement said.

In late-day trading, the Dow Jones industrial average was 157.34 points, or 1.27 per cent lower, while the broader Standard & Poor’s 500-stock index declined 15.46 points, or 1.17 per cent. The technology heavy Nasdaq lost 34.46 points, or 1.25 per cent.

European indexes all closed down at least 2.1 per cent, pushed lower by the S.&P. revision and the concerns about the debt crisis in Europe.

Laura LaRosa, the director of fixed income for Glenmede, said before the announcement on Monday that traders were assessing events in the euro zone, where a nationalist political swing in Finland and speculation about a possible restructuring of Greek debt put pressure on euro-zone assets.

Investors, reminded that the region’s sovereign crisis is not yet resolved, responded to an election on Sunday in which Finnish voters ousted their government and gave a lift to a nationalist party that is skeptical of the financial bailouts of Ireland, Greece and the agreement, reached this month, to aid Portugal.

Those results could complicate Europe’s plans to rescue Portugal, according to analysts.

Separately, news reports over the weekend suggested that the German government has been floating the possibility of a voluntary restructuring of Greece’s sovereign debt, something that most investors see as inevitable. The reports appeared to refer to extending the duration of debt issues over a longer timeframe.

Adam Cole, head of foreign exchange strategy at RBC Capital Markets in London, said the euro was being undermined in the near term by the uncertainty of the Finnish vote.

The conservative National Coalition Party won the election, but by a narrow margin over the left-leaning Social Democrats. Just behind them came the True Finns, an anti-immigration party that does not believe that Finland should rescue its European partners.

The Social Democrats have also called for changes to how those countries are financed.

The National Coalition, part of the outgoing center-right government and a strong advocate for European integration, will now have to invite others into coalition talks, raising questions about Finland’s support for rescue packages that need unanimous approval in the 17-member euro zone.

The election results are “likely to result in some noisy horse trading in the coming days,” Mr. Cole said in a research note. However, he added that “ultimately, it is unlikely that Finland will derail the Portuguese bailout process and there is in any case a fairly large ‘window’ before Portugal faces heavy redemption pressure in mid-June.”

At a sale in Madrid, the Spanish government was forced to pay substantially more to issue 12- and 18-month Treasury bills on Monday compared with last month, Reuters reported, amid concern over the Portuguese bailout and speculation about a Greek restructuring.

The benchmark Spanish 10-year issue yield rose by 13 basis points, pushing wider its spread over equivalent German bonds.