httpvh://www.youtube.com/watch?v=XRKPCeom5z8
Impotent ratings agencies pre-Lehman, now trigger happy on Europe. May cause credit crisis 2.0.
• Aussie crashes then recovers amidst debt debacle.
• China maintains the status quo.
• US “flirting with disaster”.
As speculation increases that European banks won’t recover their debts, so too do the yields of government debt and so too does the cost of insuring against this risk of default. Here lies the self fulfilling prophecy, at the spearhead of which are the ratings agencies consistently downgrading government debt. This week we’ve seen ratings agency Moody’s downgrade Ireland’s debt to the same level of Greece and Portugal – junk bonds. Moody’s downgrade included the assessment that “implementation risks remain significant “regarding fiscal consolidation and that the decision was “primarily driven by their concern about the prospect of private investor participation in future financial support programs”. That may be the case, but downgrading the bonds to Ba1 is a vague assessment of reality and an example of the ratings agencies embellishing the risk. There is now the risk of contagion to larger economies, namely Italy, Europe’s largest borrower, with French banks holding US$400billion in Italian debt on their books. The terms of a possible restructure/default will be up for further consideration at an ECB meeting later in the week while the risk of a failure of credit markets continues. The most important question however is since when did ratings agencies become such authorities on finance.
The Australian dollar was free-falling amidst more European headlines however strong economic data out of China ensured the Aussie rallied once more. China’s economic behemoth has continued to outperform with Retail Sales at 17.7% and Industrial Production at 15.1% both outstripping estimates while GDP fell moderately to 9.5%. Of important note however was the Chinese level of inflation, with CPI recording a 6.4% increase in prices in the previous 12 months. This signals the likelihood of further rate hikes in China which will need to put its economic panda on a diet to limit the risk of a significant economic reduction. This may mean the end of the Chinese economy “saving” the Aussie from the Europeans self imploding. Locally the Aussie dollar had its own supporters with a strong jobs figure of 23.4K while consumer confidence was particularly weak.
The fiscal and monetary policy stance in the US has never looked this precarious. On the monetary front the Fed Reserve isn’t sure on whether further extraordinary stimulus is warranted to achieve their dual mandate of containing inflation and reducing the unemployment rate. Not only is it ideologically subversive but higher inflation, previously predicted as transient, may force their hand to contain price rises. Furthermore, Republicans and Democrats are in a war of words regarding the budget deficit, about what services should be cut and which tax cuts should be maintained. The policy debate could lead to the unlikely scenario of a debt default on August the 2nd, which would wipe away the Fed’s influence as treasury prices would tumble. Watch out for US policy announcements leading up to that date as things heat up in congress. Nonfarm Payrolls last Friday highlighted the need for strong leadership regarding both the monetary and fiscal stance to halt the economic malaise.
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