John Malloy – CNBC.com August 8, 2011
Standard & Poor’s may downgrade the long-term credit rating of the U.S. once again in less than three months after sending shockwaves through the bond and stock markets by stripping the nation of its top notch triple-A rating last week, according to an emergency Sunday night conference call for clients of Bank of America Merrill Lynch.
“We do expect further downgrades,” said Ethan Harris, North American economist, on the call. “We doubt the newly appointed bipartisan commission will come up with a credible long-term deficit reduction plan. Hence by November or December we would not be surprised to see S&P downgrade the debt again from AA-plus to AA.”
Harris said that the U.S. should have avoided the downgrade in the first place by meeting S&P’s demands of a $4 trillion deficit cut and a “demonstrating a sensible budget process.” What they got instead was a “deficit cut of $2.1 trillion and a budget process that’s been extremely chaotic,” said Harris.
The 45-minute call was moderated by Michael Hartnett, chief equity strategist for the firm. Along with Hartnett and Harris, six other top strategists from various fields were on the call. Hartnett made references a couple times to how many clients from Asia were listening in on the call. That’s probably with good reason as China owns $1.2 trillion in U.S. debt.
“If a disorderly Treasury market leads to the Fed embarking on QE3, repercussions for the dollar will be catastrophic,” said David Woo, head of global rates and currencies research, on the call. “Investors will be quick to conclude that U.S. monetary policy has been subjugated by fiscal policy and the Fed’s independence would be placed seriously into question.”
The Federal Reserve meets on Tuesday and investors speculate that the central bank will acknowledge the recent stall in the economy.
How bad they describe the economic conditions in their Tuesday statement could give investors a hint as to how quickly they may move to stimulate once again.
“My view is that the Fed is pretty low on ammunition right now,” said Bank of America Merrill Lynch’s Harris, who puts the chances at a recession over the next 12 months at one in three. And another recession could cause some surprising actions from Ben Bernanke, he said on the call.
“If we are in a recession and the economy started to look extremely fragile, then the nuclear option for the Fed is to announce a target for 10-year yields,” said the economist. “Say the target for the 10-year is set at 1 1/2 percent. That’s an open-ended buying promise and when they announce it, they probably don’t end up buying that much because the markets will move there right away.”