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Emac's Bottom Line

Moody's Threat of US Downgrade Departure from S&P's Warning

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Compare and contrast the downgrade threats from Moody's Investor Services today with Standard & Poor's warning back in April and you'll see Moody's cites the debt ceiling fight in Washington, whereas S&P assiduously does not.

Why do I bring that up? Because it underlines the politically charged nature of a downgrade threat, which is bearish for the U.S. dollar. Citing the debt-ceiling fight puts pressure on DC negotiators to hammer out a deal. S&P was more sanguine that a deal would be reached, but it is more worried there is no credible plan to tackle the $14 trillion in debt, which is more than the entire Eurozone and is more than China and Japan combined.

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Here's what Moody's said, emphasis mine:

1) The likelihood that Moodys will place the US governments rating on review for downgrade due to the risk of a short-lived default has increased. Since the risk of continuing stalemate has grown, if progress in negotiations is not evident by the middle of July, such a rating action is likely. The Secretary of the Treasury has indicated that the government will have to drastically reduce expenditure sometime around August 2 if the debt limit is not raised; the initiation of a rating review would precede this date.

2) If a debt-ceiling-related default were to occur, Moodys would likely downgrade the rating shortly thereafter. The extent of and length of time before a downgrade would depend on how factors surrounding the default affect the governments fundamental creditworthiness, including (a) the speed at which the default were cured, (b) an assessment of the effect of the default on long-term Treasury borrowing costs, and (c) measures put in place to prevent a recurrence. However, a rating in the Aa range would be the most likely outcome. Any loss to bondholders would likely be minimal or non-existent, as Moodys anticipates that a default would be cured quickly.

3) If default is avoided, the Aaa rating would likely be affirmed after any review. Whether the outlook on the rating would be stable or negative would depend upon whether the outcome of the negotiations included meaningful progress toward substantial and credible long-term deficit reduction. Such reduction would imply stabilization within a few years and ultimately a decline in the governments debt ratios, including the ratio of debt to GDP.

Now here's what S&P said back in April, which back then gave the market a temporary, transient stroke:

S&P: Debt Ceiling Deal Not Factor In Outlook Change

S&P: Expects Debt Ceiling To Be Raised

S&P: Doesn't See Push For Meaningful Agreement In Next 2 Months

S&P: Underlying Trajectory Of US Debt Burden Still Rising

S&P: Negative Outlook Means 1 In 3 Chance Of Rating Cut

S&P: Credibility Of Any US Debt Reduction Deal Still Uncertain

S&P: US Outlook Changed On "Gulf Of Differences" Over How To Cut Debt

S&P: S&P Affirms Rtgs On United States; Outlook Revised To Negative

Here's what's important to underscore. Since 1989, S&P has lowered the ratings of 101 out of 174 sovereigns after giving hitting them with a negative outlook. On average, downgrades came six months after an outlook change, while a return to a stable outlook from negative on average happened after 15 months, says Chris Turner, head of FX strategy at ING.

Overall, a weaker dollar is the outcome of such a ratings agency action. Especially given that a lot of U.S. debt is foreign held, unlike Japan.

S&P has noted that US external debt as a percentage of current account receipts is now 140% versus a 40% median for the rest of the triple-A rated universe.

Worth noting, too, is that changes in ratings usually are lagging indicators, usually occurring after an economic downturn. The rating agencies also don't track each other in terms of when downgrades occur. Moodys took away Japan's triple-A in 1998; S&P followed three years later in 2001.

And although further downgrades have come since, and despite the fact it has the heaviest debt burden, Japan still borrows at rock bottom rates, thanks to deflation -- because its domestic savers are, shall we say, faithful that their government securities won't default.

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