I haven’t written much lately given that much of what I have to say reflects my annoyance with the distortions still present in the market. I risk sliding into a potential rant rather than being helpful to anyone who reads.
Today, however, I will try and tackle the recent downgrade of U.S. debt by the Fitch rating service. First of all, this is not a “first”. S&P downgraded U.S. debt in 2011.
As a second point, many are screaming “politics” but the Fitch argument is a simple one and is as follows:
1. Economic growth will be slowing (recession or not) over the next few quarters 2. Given slower growth there is a potential for higher unemployment and a reduction in spending. 3. Following from this will likely be lower revenues to the government. 4. Alongside this is the fact that the increase in interest rates is not only working to slow growth, it is increasing the cost of debt service for the outstanding 33 trillion debt. 5. Consequently, deficit spending will be increasing as revenues drop and debt costs rise. 6. Interest rates costs for the debt Fitch projects to be close to 6 plus percent of the budget (higher than other countries that they rate as triple A) 7. On a subjective note, with looming social security and medicare budget concerns, Fitch sees a continued inability for the political environment to work effectively to solve these issues. Within their analysis they compare U.S. metrics against other countries that they hold to a AAA standard and find the U.S. wanting. In essence, our management (or lack thereof) of debt is a problem. Likely the next few days will be filled with politicians blaming each other for the situation but in the meantime the market will likely – at least for the short term – pull back some as the longer term growth thesis is questioned. To that end we will trim some positions, but I don’t believe the Fitch report will have a long term effect (by long term I mean a year or two). Negative market reaction, however, might continue for a couple of months. Corporations for the most part are better at managing their cash flow and balance sheets and can handle these market distortions. The best outcome from the downgrade might be that our system gets reminded that good fiscal management is central to good governance and problems start to get solved. We shall see.
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