Tuesday, October 15, 2013 - Downgraded and Defaulted

Downgraded and Defaulted
by Sinclair Noe

DOW – 133 = 15,168
SPX – 12 = 1698
NAS – 21 = 3794
10 YR YLD + .03 = 2.72%
OIL – 1.49 = 100.92
GOLD + 7.70 = 1282.00
SILV + .03 = 21.40

For most of the day the Dow Industrials were drifting just a little lower but as the afternoon dragged on it became more and more obvious that the politicians in Washington are still dysfunctional and signs of progress towards a resolution on the debt ceiling remain illusory. The House of Representatives started the morning with yet another plan that had no chance of success, and they were essentially sent back to the drawing board. Selling accelerated during the afternoon after Senator Richard Durbin said Senate negotiations had been suspended until House Speaker John Boehner can work out a fiscal plan that can proceed in the House of Representatives.

Losses were broad, with all 10 S&P 500 sectors falling on the day. Three-fourths of stocks traded on the New York Stock Exchange ended lower while 68 percent of Nasdaq-listed shares fell. The situation in Washington has driven trading lately, overshadowing the beginning of a busy week of earnings. Citigroup Inc reported weaker-than-expected results as the bank was hit by a double-digit drop in bond trading revenue for the quarter. Johnson & Johnson reported stronger-than-expected quarterly results on strong growth for its prescription drugs, while Coca-Cola Co reported revenue slightly under expectations. Intel reported revenue that topped expectations. CSX Corp and Yahoo Inc both also rose after posting results after the close. Since the government shutdown 2 weeks ago, the markets have dropped, then we had a few days of recovery, and the net change pretty much a wash. But now we're running out of time.

Fitch Ratings has placed the United States of America's 'AAA' Long-term foreign and local currency Issuer Default Ratings on Rating Watch Negative. The Rating Watch Negative would be a step toward cutting the credit rating. Fitch says it believes that the debt ceiling will be raised soon, but the political brinkmanship and reduced financing flexibility could increase the risk of a default.

The current 'AAA' rating also reflects the halving of the federal budget deficit since 2010, which is now approaching a level consistent with debt stabilisation.  The prolonged negotiations over raising the debt ceiling (following the episode in August 2011) risks undermining confidence in the role of the US dollar as the preeminent global reserve currency, by casting doubt over the full faith and credit of the US. This "faith" is a key reason why the US 'AAA' rating can tolerate a substantially higher level of public debt than other 'AAA' sovereigns. The repeated brinkmanship over raising the debt ceiling also dents confidence in the effectiveness of the government and political institutions, and in the coherence and credibility of economic policy. It will also have some detrimental effect on the US economy.

So, that's the latest blast from Fitch. If we hit Thursday without a deal, the best estimate is that most people wouldn't immediately notice the government has hit the debt ceiling, not right away. The government by law will no longer be able to add to the national debt, and will have to rely on incoming revenue and about $30 billion in cash to pay the nation's many obligations. Unless Congress raised the nation's debt ceiling, the money would be gone within days.

Some people claim the government is out of money, which is kind of silly. The government creates money; all the government has to due is issue bonds and the Federal Reserve will create the money. So the only way we can really be out of money is if we artificially say we will stop creating money; and right now, that seems to be the deal. You've heard the analogies of how the US budget is like a family budget, and the family ran up debt on the credit card. That's not true. The government is not like your family; the government can create money out of thin air; the government has a printing press. And on Thursday, the government faces the prospect of turning off the printing press.

That means the government will have to rely on incoming revenue and about $30 billion in cash to pay the nation's many obligations. Unless Congress raised the nation's debt ceiling, the money would be gone within days. The Congressional Budget Office estimates Washington would start missing payments between October 22 and the end of the month. America could miss a $12 billion payment due to its Social Security pension program on October 23. And with a few missed payments the economy will freeze up and lock up and grind to a halt.

It might happen before then. The political dysfunction would likely lead to a sharply diminished appetite for risk, which in turn would undermine equities; expect stocks to take a big hit. Sentiment for safe haven assets have already started to sour. In recent days, major money market mutual funds, including Fidelity, JPMorgan and Pimco; have started shunning US debt that comes due between October 17 and the middle of November.

Also, US Treasuries are used as collateral for trillions of dollars of financial deal; any default changes the understanding of that collateral and would likely result in massive defaults. Remember that a big chuck of those deals are also backed by derivatives, such as credit default swaps. If default triggers those swaps then the problems intensify exponentially. The problem with Credit Default Swaps are that they are used like a form of insurance, but unlike insurance the sellers don't have reserves in place to pay for claims in the actual event of a default. So, if there is a default, then everything freezes because nobody will know what anything is worth.

So the big question is whether the politicians will screw this up and default, or as the New York Times described: “a legislative failure and an economic catastrophe that could ripple through financial markets, foreign capitals, corporate boardrooms, state budget offices and the bank accounts of everyday investors”.

There is a reasonable argument that we've already started defaulting. Right now, with the shutdown, we’ve already reached the point at which the government is breaking very important promises indeed: we promised to pay hundreds of thousands of government employees a certain amount on certain dates, in return for their honest work. We have broken that promise. And the fact that many firms have stopped buying and sold short-term Treasuries also means the global faith in US institutions has already been undermined. The pieces of the catastrophic puzzle are in place.

And that means that economic growth will be slower than it should be, unemployment will be higher, unrest will grow. This government-by-crisis approach has cost the economy about 900,000 jobs and raised the unemployment rate by about 0.6 percent, according to a study by private forecasting firm Macroeconomic Advisers, commissioned by the Peter Peterson Foundation. Macroeconomic Advisers said in a press release: "Partisan divided government has failed to address our long-term fiscal challenges sensibly, instead encouraging policy that is short-sighted, arbitrary, and driven by calendar-based crises.”

Macro Advisers estimates that the government shutdown has already shaved about 0.3 percent from economic growth in the fourth quarter. A short debt default, starting Thursday and wrapping up within a few days, before any actual non-payment occurs, could cause unemployment to spike to 8.5 percent from 7.3 percent and cost 2.5 million jobs, Macro Advisers estimates. A longer default, lasting a couple of months, would cause an even deeper recession, pushing unemployment to 8.9 percent and costing 3.1 million jobs. All of this has weighed on economic growth -- which in turn has made government finances worse than they needed to be. Macro Advisers estimates that the austerity of recent years has cut GDP growth by 0.7 percent and cost 1.2 million jobs already.

While debt default is undoubtedly the worst of all possible worlds, then, the bonkers level of Washington dysfunction on display right now is nearly as bad. Every day that goes past is a day where trust and faith in the US government is evaporating — and once it has evaporated, it will never return. The Republicans in the House have already managed to inflict significant, lasting damage to the US and the global economy — even if they were to pass a completely clean bill tomorrow morning, which they won’t. The default has already started, and is already causing real harm. The only question is how much worse it’s going to get.

So, here's where we stand. On a day of political drama and confusion, House Republicans first proposed their own version of a Senate plan to temporarily end the political stalemate paralyzing Congress, then haggled among themselves over the details before finally agreeing to vote on it Tuesday night.

But shortly after announcing the planned vote, the House committee that sets the rules for such procedures postponed its hearing. There are some indications that the GOP leaders are struggling to round up the votes. Another factor is that apparently the conservative groups Heritage Action and Freedom Works came out against the plan. So, for now it looks like there will be no House vote today.

The conservative groups both said they will "key vote" a bill that was expected to hit the House floor Tuesday night.  Heritage Action said in a statement: "Unfortunately, the proposed deal will do nothing to stop ObamaCare’s massive new entitlements from taking root — radically changing the nature of American healthcare." 

Thursday, October 10, 2013 - Goodbye Jamaica

Goodbye Jamaica

by Sinclair Noe

DOW + 323 = 15,126
SPX + 36 = 1692
NAS + 82 = 3760
10 YR YLD + .03 = 2.68%
OIL + 1.35 = 102.96
GOLD – 20.60 = 1287.40
SILV - .21 = 21.78

Over the past few days we've been hearing that a government default wouldn't be a big deal; that a default wouldn't actually mean default. But it turns out that avoiding a default is a very good thing indeed. Hope over a deal in Washington put the bid back in stocks; and for right now it is just hope for a deal on the debt ceiling, not an actual deal yet; and quite possibly no deal on the government shutdown. We may not get the government running again but the politicians finally realized that they can't strap a suicide bomb vest on US Treasuries.

We may have a bunch of idiot politicians in Washington...,

Yeah, we do have a bunch of idiot politicians in Washington. And they still have a lot of work to do. Republicans in the House of Representatives offered a plan to postpone the default for 6 weeks; President Obama has indicated that if a clean debt limit bill is passed, he would sign it, even if the government remains shut down. That might be a stumbling point. In another potential wrinkle, the GOP plan might permanently ban the Treasury Department from using extraordinary measures to avoid default; so in some ways it isn't a truly clean bill; plus it is very short-term, meaning we get to go through this again around Thanksgiving.

The possible extension means there is the possibility of broader budget talks, including possible deficit reduction. The prospect of broad budget talks is reviving worries among some liberals that Mr. Obama would agree to steps to trim Social Security or Medicare benefits to win Republican concessions, and one area in particular seems ripe – the chained CPI. That remains to be seen.

Bloomberg is reporting on a conversation between Obama and John Podesta, an informal adviser and former chief of staff to President Clinton; just before Obama was re-elected, he vowed to Podesta that he would never again bargain with Republicans to extend the debt limit. The precedent, set in the agreement that ended a 2011 budget standoff, “sent a signal that this was fair game to blackmail over whether the country would default.” According to Podesta, “He feels like he has to end it and end it forever.”

The stand Obama has taken on the latest fight over the government shutdown and borrowing limit -- refusing to tie policy conditions to raising the debt ceiling -- is an attempt to repair some of the damage that he and his aides believe he sustained by making concessions to Republicans to avert a default two years ago.

The Republicans will renew their attack on Obamacare. Heritage Action, the Koch brothers funded, conservative group leading the charge against the health care law has agreed to raising the debt limit but maintains that any measure re-opening the government would be met by demands for killing Obamacare. Just in case you were wondering why something is happening now, it's because the big money players from Wall Street and Big Oil were getting worried, and they started pulling the strings. We may have a bunch of idiot politicians in Washington, but they're the best idiot politicians money can buy. And this is why it is too early to say the deal is in the bag. Conservative Republicans might not throw their support behind Boehner's plan. Boehner made no mention of Obamacare this morning during his remarks.

So, we get a possible, temporary impasse on the debt ceiling, and no movement on the government shutdown, and the Dow industrials jump 300 points. Just imagine the temper tantrum Wall Street would have thrown if we had defaulted.

And then the cherry on top is that all of the fiscal dysfunction means the Federal Reserve FOMC is less likely to take action when they meet October 29-30, especially in light of the damage done by the shutdown. Then you also can consider the nomination of Janet Yellen, a dove, likely to prefer monetary stimulus to backsliding. Yesterday, the Fed released minutes of the September FOMC meeting and one of the concerns dealt with the “considerable risks surrounding fiscal policy.”

There are risks to fiscal policy. Today, a report that initial claims for unemployment benefits jumped 66,000 last week to 374,000. Exactly how much economic damage results from the shutdown will be hard to determine. Pollster Nate Silver, the guy who actually got the numbers right on the election, says the media is probably overstating the magnitude of the shutdown's political impact. Remember Syria? The fiscal cliff? Benghazi? The IRS scandal? The collapse of immigration reform? All of these were hyped as game-changing political moments by the news media. Yeah, not so much. Of course, if the not-yet-done deal doesn't get done and we go into default or if the shutdown lasts a long time, then the magnitude of the impact is being understated.

And all those polls you're seeing suggesting that the GOP is cratering with regards to public approval, and pulling the Democrats down with them, well all those polls probably won't translate in changes in the re-election efforts of incumbents, or the makeup of the House or Senate. And according to Silver's analysis the degree of polarization in Congress is higher than at any point since the Great Depression by a variety of measures, and is possibly at its highest point ever. It is very partisan, and that means there is a great amount of uncertainty. And so the Fed FOMC minutes were correct, there are risks to fiscal policy.

So, the markets bounced today, but it's not a done deal.

Something else I wanted to cover today. With all the political insanity, you might have missed an important story in the journal Nature. Try to think back to the hot days of summer. Now try to remember the hottest summer of the past 20 years. It's tough to put the exact date on it but we can all remember some brutal heat in the desert southwest; a hot spell where temperatures topped 110 or 115 for several days in a row. Well, there will come a time when we'll look back on those days as the good old days. Within a generation, whatever climate we were used to will be a thing of the past. The hottest, most extreme weather will be the average.

According to the new study, the mean annual climate of the average location on Earth will slip past the most extreme conditions experienced during the past 150 years and into new territory by between 2047 and 2069, depending on the amount of climate-warming greenhouse gases that are emitted during the next few decades. Once a location reaches the transition point, the average temperature of its coolest year will be greater than the average temperature of its hottest year for the past 150 years. Even more strikingly, the study found that the oceans, which have absorbed about half of the man-made carbon dioxide (CO2) emissions since the dawn of the industrial revolution 250 years ago, exceeded their historical bounds of pH measurements back in 2008. In other words, the oceans are becoming highly acidic.

Even with aggressive cuts in greenhouse gas emissions, the study found, the projected near-surface air temperature of the average location on Earth will move beyond historical variability in about 56 years from now. A business-as-usual scenario in which emissions continue on their current upward trajectory would see an unprecedented climate occurring 20 years sooner than that, in 2047. And they even break it down by city. New York will reach a tipping point by 2048; Los Angeles will get to the point of no return in 2048; Mexico City in 2031; Phoenix is 2043; and Kingston Jamaica will be there in 10 short years.

The boundary of passing from the climate of the past to the climate of the future really happens surprisingly soon. The study shows that tropical areas, which contain the richest diversity of species on the planet as well as some of the poorest countries, will be among the first to see the climate exceed historical limits — in as little as a decade from now — which spells trouble for rainforest ecosystems and nations that have a limited capacity to adapt to rapid climate change.

According to the study, conducted by a team from the University of Hawaii, about 1 billion people currently live in areas where the climate will exceed historical bounds of variability by 2050. This number would rise to 5 billion people under a business-as-usual emissions scenario, which is the emissions path the world is currently on. We could slow down, by cutting emissions we might buy more time until we hit the tipping point, but according to the new study, we will hit it.

The study is hardly the first to document the steady march toward hotter temperatures around the globe. Less than two weeks ago,the Intergovernmental Panel on Climate Change (IPCC) released its fifth report, describing a planet that is warming at an accelerated pace because of human activity. The past three decades have been the hottest since 1850, according to the panel established by the United Nations, which added that warming and sea-level rise will continue through the 21st century.

But by predicting the tipping point when traditional climates will be replaced by hotter futures, the new study provides a fresh way to look at the problem. There are several things we can start to look for, including changes in food production, especially from the tropics; water scarcity due to drought; and the prices will be affected as big agriculture responds, and much more, right down to specific locations.

Sorry Jamaica.