Global insights audio-slides-07-29-11

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  • 77.58 Yen to the DollarThe risk of a one-notch downgrade in US Treasury Debt would imply a series of systemic risks AND MONEY MANAGERS ARE NOW PREPARING FOR. I will go through those risks in a couple of slides
  • On 18 April, Standard & Poor’s put the US AAA sovereign debt rating on negative outlook and on 14 July it went one step further and placed the AAA rating on “CreditWatch with negative implications” According to the statement issued on 14 July “Standard & Poor’s use[s] the CreditWatch to indicate a substantial likelihood of it taking a rating action within the next 90 days, or in response to events presenting significant uncertainty to the creditworthiness of an issuer” Standard & Poor’s “may lower the long-term rating on the US by one or more notches into the ‘AA’ category in the next three months, if we conclude that Congress and the Administration have not achieved a credible solution to the rising US government debt burden and are not likely to achieve one in the near future”.Standard & Poor’s states that in its baseline scenario US net general government debt would reach 84% of GDP by 2013, which indicates a “relatively weak trajectory compared with those of the US’s closest ‘AAA’-rated peers (France, Germany, the UK and Canada)”. It also specifically highlights that the debt trajectory is expected to “continue increasing in the medium term if a medium-term fiscal consolidation plan of USD 4 Trillion is not agreed upon”. This probably means that US politicians have to come up with savings very close to the USD 4 Trillion mark in order to avoid a downgrade. So far, the two proposals from the Democrats and Republicans are at best close to or just below USD3bn – and hence not close to what Standard & Poor’s seems to require to avoid a downgrade. Finally, Standard & Poor’s highlights that for a plan to be credible it has to be bipartisan. -- Need to know three things: 1- Are they actionable? 2- Can they be implemented? 3- And are they credible? Moody’s has also put the US under review for a possible downgrade, although this is mostly linked to the risk of a default in the short term should the debt limit not be raised. Moody’s is less explicit about the exact terms of a downgrade should the debt limit be raised. However, we believe that it would very quickly follow with a downgrade should Standard & Poor’s announce a downgrad
  • Real deadline for default may not be 2 August There is some uncertainty over whether the deadline has changed as tax revenue for July has been higher than expected. Some calculations suggest the government may have another one to two weeks. So far, the US Treasury has not changed the date for when it expects to run out of money – most likely because president Obama wants to keep maximum pressure on politicians in order to get a deal through. However, it may suggest that should a plan not be ready for the president’s signature before 2 August there could be scope for more time before the money runs out. Another issue is whether the US would actually default should the debt limit not be raised by 2 August. It seems likely that the government would decide to hold back payments to government employees and federal government contractors instead so it could still meet its debt obligations until a deal is in place. Hence, even if a deal is not in place before the government runs out of money, we do not believe a default would be the first outcome. However, it would be a terrible signal to financial markets to have to hold back government payments. Credibility in politicians’ ability to steer the US economy properly in the current troubled waters would deteriorate even further and it would be likely to send shock waves through the financial markets. Obama able to raise debt limit if Congress fails The US president will be able to lift the debt ceiling although no political agreement between Democrats and Republicans is found in time to avoid a debt default There are two suggestions currently up for discussion among lawmakers. 1. Former President Clinton has identified a constitutional escape hatch should Obama and Congress fail to come to terms on a deficit reduction plan before the government hits its borrowing ceiling. A provision in the 14th Amendment gives, according to some legal experts, the president the powers to ignore the debt ceiling if any other means are exhausted. 2. Senate minority leader Mr McConnell has proposed to flip the current process upside down by calling on Congress to disapprove rather than approve an administration request for a debt limit increase. It would then allow the president to veto the disapproval if it clears Congress, allowing the debt limit to be raised to avoid a default. Although president Obama has expressed doubts about both options, it is worth knowing that the president will still have options to avoid a default if the political negotiations on Capitol Hill is not finished before the deadline at the start of August.
  • NIETHER ACHIEVE THE RATING AGENCIES REQUIREMENTS – HAD CONGRESSIONAL HEARINGS THIS – EXPECT THE RATING AGENCIES TO BE MUZZLED1. Republicans propose a two-step plan for raising the debt limit. A first step would postpone the deadline by six months, with another increase then in the limit tied to further savings coming from a bi-partisan Commission. President Barack Obama has strongly opposed this and his spokesman has said he would veto such a plan. The latest signs from Republicans are that it will be adjusted after the Congressional Budget Office (CBO) said the plan implied only USD850bn in savings. This would mean the rise in the debt limit would be even shorter than the six months, putting Republicans even closer to a collision course with the Democrats.2. Democrats are also opposed to the Republicans’ proposal of putting caps on spending. President Obama says it would hurt investment in infrastructure, R&D investment and education, on which future growth in the economy should be based. 3. There is also disagreement on the balanced budget amendment proposed by Republicans. This has actually previously been approved in the House but did not go through the Senate where Democrats have a majority. Overall, some clear obstacles still need to be removed. With both parties also struggling to keep their own party in support of their individual plans, there is still some work to be done.
  • The risk of a one-notch downgrade would imply the following systemic risks AND MONEY MANAGERS ARE NOW PREPARING FOR• Some money market funds, index funds, mutual funds and insurance companies are bound by covenant to invest only in AAA papers. This investor segment might be forced to reduce or close down holdings of US Treasuries if the AAA rating is lost. This could amplify the sell-off in Treasuries. In this case, some funds may choose to change their covenants to be able to include non-AAA papers. However, this might lead investors to move out of money market funds, which in time could lead to a squeeze in the money market. • Treasuries are widely used as collateral in the repo, OTC derivates and futures markets. A lower rating of US treasuries is likely to imply a larger haircut on treasuries in these financial transactions. In turn, this could lead to margin calls on counter parties implying a liquidity or funding squeeze in some markets. • First several government sponsored agencies including Fannie Mae, Freddie Mac, the Federal Home Loan Bank System and Farm Credit System Banks would be likely to be downgraded in tandem with the US government.• Second, a variety of bonds or other liabilities that are directly or indirectly guaranteed by the US could come under review or be downgraded. For instance, Israeli and Egyptian bonds guaranteed by the US would be likely to be downgraded if the US government loses its AAA rating. • Several US financial institutions, among others large US insurers and securities clearing houses, seem likely to be downgraded along with the US as they are constrained by the US sovereign credit rating. • Finally, a downgrade of the US government would have a knock-on effect and initiate a series of other downgrades. The wave of subsequent downgrades could lead to a financing squeeze for financial institutions and further deterioration in financial conditions. As the No. 1 risk-free asset in the world, most risk assets would have to be reprised lower if the downgrade turns out to be permanent, as the long-term global cost of capital would also be affected negatively
  • An Italian company calledFinmeccanica posted weak second-quarter results. However, this was a disappointment taken far more seriously by the market; the defence firm’s spreads widened by 70bp to 285bp. First-half profits were well below expectations, and the firm’s decision to lower its revenue forecast for the year and withdraw its operating profit entirely was received badly by the market. It also highlighted “structural” issues that need to be addressed, adding to risk on this name.
  • Global insights audio-slides-07-29-11

    1. 1. This chart is from the discussion recordedJuly 29th, 2011<br />WEEKLY WRAP<br />Listen to the original recording for this slide at either www.TraderView.com/GlobalInsights or www.GordonTLong.com/GlobalInsights<br />
    2. 2. This chart is from the discussion recordedJuly 29th, 2011<br />YEN CARRY TRADE UNWIND: Accelerating<br />Listen to the original recording for this slide at either www.TraderView.com/GlobalInsights or www.GordonTLong.com/GlobalInsights<br />
    3. 3. This chart is from the discussion recordedJuly 29th, 2011<br />A FREIGHT TRAIN OUT OF CONTROL?<br />Listen to the original recording for this slide at either www.TraderView.com/GlobalInsights or www.GordonTLong.com/GlobalInsights<br />
    4. 4. This chart is from the discussion recordedJuly 29th, 2011<br />THERE IS TIME<br />Listen to the original recording for this slide at either www.TraderView.com/GlobalInsights or www.GordonTLong.com/GlobalInsights<br />
    5. 5. This chart is from the discussion recordedJuly 29th, 2011<br />DOESN’T ADDRESS DOWNGRADE WARNINGS<br />Listen to the original recording for this slide at either www.TraderView.com/GlobalInsights or www.GordonTLong.com/GlobalInsights<br />
    6. 6. This chart is from the discussion recordedJuly 29th, 2011<br />IS CONGRESS ARGUING THE RIGHT ISSUES?<br />Listen to the original recording for this slide at either www.TraderView.com/GlobalInsights or www.GordonTLong.com/GlobalInsights<br />
    7. 7. This chart is from the discussion recordedJuly 29th, 2011<br />WORLD LOSING (Lost?) CONFIDENCE IN US<br />Listen to the original recording for this slide at either www.TraderView.com/GlobalInsights or www.GordonTLong.com/GlobalInsights<br />
    8. 8. This chart is from the discussion recordedJuly 29th, 2011<br />TURMOIL & INSTABILITY<br />CME Not Accepting T-Bills as Risk Free - Now Discounting for Collateral<br />Listen to the original recording for this slide at either www.TraderView.com/GlobalInsights or www.GordonTLong.com/GlobalInsights<br />
    9. 9. This chart is from the discussion recordedJuly 29th, 2011<br />THE EU CRISIS IS NOT RESOLVED!<br />Listen to the original recording for this slide at either www.TraderView.com/GlobalInsights or www.GordonTLong.com/GlobalInsights<br />
    10. 10. This chart is from the discussion recordedJuly 29th, 2011<br />THE EU CRISIS IS NOT RESOLVED!<br />Moody’s puts Spain on review for downgrade - Rating agency cites terms of Greece package for move <br />Listen to the original recording for this slide at either www.TraderView.com/GlobalInsights or www.GordonTLong.com/GlobalInsights<br />
    11. 11. This chart is from the discussion recordedJuly 29th, 2011<br />WEEKLY WRAP<br />Listen to the original recording for this slide at either www.TraderView.com/GlobalInsights or www.GordonTLong.com/GlobalInsights<br />

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