The Dollar's Surprising Reaction to a Negative US Debt Outlook

Sniffing the obvious, Standard & Poor’s cut its outlook for US sovereign debt from stable to negative this morning.

“We believe,” reads a statement released with the announcement, “there is at least a one-in-three likelihood that we could lower our long-term rating on the US within two years.”

As we type, the Dow is down more than 200 points. The S&P hangs by its fingernails to 1,300. And the yield on a 10-year Treasury has inched its way to 3.44%

For the record… or, should we say, for what it’s worth… S&P still considers US debt AAA.

Given the fact the US government is 28 days away from bumping up against the $14.3 trillion debt ceiling, we suspect the question of Uncle Sam’s ability, let alone political will, to pay is too obvious to ignore.

The current White House budget plan requires lifting the ceiling to $20.8 trillion by 2016. Wisconsin Rep. Paul Ryan’s plan, passed by the House on Friday, would require a ceiling of $19.5 trillion, according to figures compiled by Bloomberg.

Alas, “we believe there is a material risk,” S&P warns, “that US policymakers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013.

“If an agreement is not reached and meaningful implementation does not begin by then, this would in our view render the US fiscal profile meaningfully weaker than that of peer ‘AAA’ sovereigns.”

Unfortunately, in the world of late, degenerate capitalism, that’s about as strongly worded as these statements ever get.

Standard & Poor’s continued to rate a host of mortgage-backed securities AAA right up to the point when they detonated in 2007-08.

“A huge part of the reason the US is in its awful financial position,” writes our friend Barry Ritholtz, author of Bailout Nation, this morning, “is due to the fine work of S&P. The ‘negative outlook’ of US debt has come about because of the inability of Standard & Poor’s to have performed their jobs rating mortgage-backed securities.

“Ultimately, this enabled the entire crisis, financial collapse, enormous budget deficit and now political [squabble] over the debt ceiling.”

Of all the AAA-rated subprime MBS issued in 2006, 93% are now junk. Barry will be joining us in Vancouver again this year. Will we be seeing you there?

Of course, on the S&P news this morning, in a move only our Abe Cofnas could pretend to understand, the dollar is rallying. In fact, at 75.4, the dollar index is the strongest it’s been for more than a week.

Oy. Chalk it up to an even uglier horse in the glue factory: the euro.

Addison Wiggin
for The Daily Reckoning