The day after the infamous downgrade of the U.S. credit rating by Standard & Poor’s, I had lunch with a long-time friend who has taught me much about the markets. I noted I was annoyed by what the agency had done and said people should dump McGraw Hill stock. She was more sanguine and said that S&P probably wanted to show some independence after the financial crisis of 2008 and its part in it. My response: Helluva time to show some spine.
And bad spine at that. As I read the S&P report and its sovereign committee’s reasoning behind it — in summary, Washington is broken — I admit to agreeing with some of the points. But as others have said, it should be the numbers, not the politics, that S&P is judging. Further, when a credit agency has been as much debased as S&P, its decision, to quote CME Chairman Terry Duffy, was "a joke."
Although many talking heads attributed the following week’s whipsaw stock market fluctuations to the downgrade, the action didn’t have much impact. After all, two other credit rating agencies kept America at AAA. Perhaps even better proof of this and a bit of irony: U.S. Treasuries rallied, showing where people put their money in volatile times. Stocks were dumped and U.S. bonds were bought despite record low yields, which as the Financial Times noted: "Take inflation into account and the yield on U.S. government bonds maturing in the next 10 years is negative."
Turns out the market swoon was due to several factors, both fundamental and technical, but a key theme was the continued instability of Europe: Riots in London, French banks under pressure and possible debt contagion spreading beyond Greece — still.
On the currency front, the Swiss franc and Japanese yen rallied, taking over the U.S. dollar’s share as a safe haven, while the dollar weakened but stayed within its channel. China seemed unmoved and unworried about America paying its debts but was disturbed by the public display of dislike our policy makers had for each other. Of course China would say that, but even I’m a bit disturbed by not so much the display, but the foolish stubbornness of certain political factions that choose fiction over fact every time.
The trouble is, all these dramas take away from what really is needed: Employment stimulus. Perhaps it was some good news that bolstered some of the market, including a rise in nonfarm payroll, up 117,000 in July, and unemployment claims that had dropped below 400,000 for the first time in four months. For a market desperate for some good news — especially on jobs — this helped support a rally.
In "Currencies outlook: Winning the ugly contest," by Assistant Editor Michael McFarlin, analysts note a key concern is that as we move away from a stimulus environment and settle into a period of austerity, we could find ourselves, and the U.S. dollar, in a deeper funk. One analyst even suggested the need for a third quantitative easing package.
One thing confuses me in the discussion about spending cuts and holding the line on taxes. Our tax rates haven’t been this low since 1950. Due to deductions, income, etc., about 47% of Americans don’t pay any federal income tax. And yet, when Bill Clinton pushed through a deficit reduction program in 1993 that in fact increased taxes on the more affluent, we went through the longest economic expansion in our history. So if it’s true that "Reagan proved deficits don’t matter," as Dick Cheney said, why aren’t we following the same road that led us to the prosperity and growth of the 1990s and even would have gotten a AAA rating from S&P?