S&P Finally Cuts It's Outlook on the US

Bugos  here.

Standard & Poor’s cut its rating outlook on the US to negative from stable today but kept its AAA rating – citing large budget deficits relative to other AAA rated governments, and no fix in sight.  That’s big news - to the market anyway.  Of course, we've been sitting here waiting for this for years... but it rocked the markets today.

Stocks fell flat on their face, and the dollar and Treasury market rallied.  Counterintuitive?  Not really because markets look ahead and equity traders sold stock because they expect higher interest rates in the long term.  The drive to liquidity as usual drove up dollar and bond values but this is a short term phenomenon.  There are big under currents in the bond market that aren’t good for bond-holders.  Today’s news is a shot across the bow... a warning shot to the market.

Maybe they’ll wait until the US government breaches (or ratchets up) the debt ceiling, or maybe they’ll wait longer, but it is near inevitable that a downgrade is coming.  Gold shot up as it should.  But, it has also been strong in the days ahead - obviously the market new this was coming.

In China they've already known this for some time.  The Dagong Global Credit Rating Co. rated US debt at just AA in a sovereign credit report ranking 50 countries last summer.  That ranked the US in 13th place on the list with countries like Norway, Denmark, Luxembourg, Switzerland, Australia, Canada and even China ranking higher.  See the news here:

http://seekingalpha.com/article/214165-the-unthinkable-u-s-stripped-of-aaa-credit-rating-by-chinese-agency

In November, the Chinese credit rating agency lowered its rating on US government debt to just A+ from AA, “citing a deteriorating intent and ability to repay debt obligations after the Federal Reserve announced more monetary easing.”

http://www.bloomberg.com/news/2010-11-09/china-s-dagong-downgrades-u-s-to-a-on-quantitative-easing-xinhua-says.html

Today the Chinese credit rating agency looks like a leader in the ratings business.  It’s views should be respected, at least more than the US ratings agencies which are always last to the party.

So expect the downgrades to come, and maybe even expect to hear similar warnings from the other ratings agencies.

What should the markets do on this news?

The precious metals should be strong – especially gold.  This news supports our view that the Federal Reserve will continue to implement quantitative easing programs to bid up government debt long after June – whatever their form may be.

We’re looking for gold to hit $1600 in the next few months with my target for the HUI still at around 700.  Technically, the gold chart is shaping up for a parabolic move, so there’s a reasonable chance it will be a bigger move than even that.

The Treasury market should continue to weaken.  This is a no brainer but a largely under-appreciated fact, yet.  That is probably because the market has become immune to bearish calls against Treasuries... especially from the gold crowd.

It’ll look different when yields start pushing 5%.

Once the smoke (market volatility) clears in the short term in reaction to news like this – or in reaction to the occasional unconvincing threat that QE2 is going to come to an end – we expect equities to advance again too, right into June.

The stock and commodity markets are likely going to continue to climb the wall of worry on the back of an unending stream of central bank “liquidity”.  For now, they are intent on calling its bluff about taking back any “liquidity.”