Stocks sell off as S&P cuts US outlook
Big news of the day is the downgrade in the US outlook by rating giant Standard and Poor’s. There can’t possibly be too many analysts who don’t see storm clouds on the horizon for the US considering their massive and growing debt levels, huge unfunded liabilities, and almost complete lack of political will to deal with these problems. Yet the market seems to have received this news as some sort of new and shocking revelation.
“Because the U.S. has, relative to its ‘AAA’ peers, what we consider to be very large budget deficits and rising government indebtedness and the path to addressing these is not clear to us, we have revised our outlook on the long-term rating to negative from stable.”
Perhaps the more significant bit of news is this statement from S&P:
“The negative outlook on our rating on the U.S. sovereign signals that we believe there is at least a one-in-three likelihood that we could lower our long-term rating on the U.S. within two years.”
More than the downgrade itself, this statement is likely what has the markets jittery. A downgrade of the United States’ credit rating would have significant repercussions on the treasury market and interest rates. Many money market funds and other mutual funds have stated limits in terms of the percentage of their holdings held in AAA rated sovereign bonds. Should the US lose that hallowed status, it would result in the forced selling of treasuries by many funds. It would also eliminate a portion of the demand both domestically and abroad. The end result would be higher interest rates on US bonds which would be passed on to consumers in the form of higher mortgage rates.
Foreign demand for Canadian bonds drops
Stats Canada today released the international transaction in securities for February 2011. Two trends are worth noting:
1) Foreigners were net sellers of Canadian bonds in February for the first time since late 2008! Foreigners sold $5.0 billion in federal bonds.
One has to wonder if this net selling in bonds was partly the cause of the jump in interest rates on the 5 year GoC bond in February.
Demand for the 5 year Government of Canada bond is extremely important as it determines interest rates on 5 year fixed mortgages. Perhaps more importantly, it helps to set the qualifying rate which is now used to assess the maximum mortgage amount an applicant qualifies for when seeking a variable rate mortgage. This is why I recently suggested that because because of these new rule changes, the housing market is increasingly at the mercy of the bond market (over which the Bank of Canada has little control).
While I suspect that this reading is not the start of a new trend, particularly in light of the S&P announcement today which will drive more capital into the true AAA countries, it certainly highlights how fickle the bond market can be, and in turn, how at risk the housing market is to swings in mood by bond investors.
2) The second trend worth noting is the rise in Canadian stock purchases by foreigners. Total purchases amounted to $4.9 billion, the highest since May of last year. This has no doubt helped buoy the TSX. The ongoing rise in commodity prices no doubt led many investors to seek out Canadian resource companies. It’s getting increasingly difficult to find bargain stocks on the TSX, particularly in the more popular resource space, though there are still a handful of well priced resource companies with strong balance sheets and reasonable valuations.
Greek restructuring would be “Catastrophic”
The near-certainty of a Greek debt restructuring has analysts chiming in on the potential implications. For those unfamiliar with the term, a restructuring typically involves the creditors of a nation accepting less than what they were promised to be repaid. A simple example of a restructuring is if I owed you $100 but couldn’t afford to repay it. Instead I offered you $80 (with the alternative being that I declare bankruptcy and you get nothing). That’s the idea.
However, as I suggested in an earlier post, restructuring has the potential to create a European financial crisis as many of the big banks are holding Greek sovereign debt. If they suddenly face a loss of their capital, they may be in trouble.
Now the Bank of Greece Governor George Provopoulos has suggested that such a restructuring is not needed (yeah right!) and would be catastrophic.
From the Globe and Mail:
A Greek debt restructuring is not needed and would be catastrophic for the country, hitting bank and pension fund assets and closing off access to capital markets, the head of its central bank said on Monday.
“The Bank of Greece has explained with clarity since last October that such a (restructuring) option is not necessary, nor desirable,” Bank of Greece Governor George Provopoulos said in a report to shareholders.
“It would have catastrophic consequences.”
A finance ministry official earlier denied a Greek media report the country had already requested restructuring talks with the EU and IMF.
Yet another sign that Europe is falling apart at the seams under the weight of the debt woes in its peripheral countries. The threat of a break up of the monetary union cannot be ruled out, particularly after the results of the Finnish election over the weekend saw the True Finns party, which ran on an openly anti-bailout platform, garner 19% of the votes, a 15% jump over the last election. Mike Shedlock made an interesting post on this.