Marching toward a precipice

By Pedro Nicolaci da Costa

WASHINGTON (Reuters) - Treasury bonds could soon lose the privilege of being the only debt securities in the world whose value actually rises on the threat of a ratings downgrade.

That is because for the first time, the United States' top-notch debt rating is in jeopardy.

U.S. Congressional leaders are refusing to lift the country's debt ceiling, preventing the Treasury from raising money it has already spent.

The political deadlock is threatening the United States' prized AAA credit grade, which major rating agencies have warned could face near-term cuts.

Even billionaire Pete Peterson, co-founder of private equity giant Blackstone, appeared to be getting worried. He has spent many years and a lot of money pushing for cuts in government spending to cut U.S. debt levels.

"The dangerous irony is that a refusal to compromise on a deal to reduce the nation's debt now will only serve to increase our debt," Peterson said in a statement.

Ironically, Peterson's often flashy anti-debt campaigns are partly to blame for the impasse, since Republican leaders have the backing of a majority of Americans on the issue, according to recent polls.

Economists say many individuals oppose the debt ceiling because they think that would mean giving a green light to additional government spending -- rather than simply making good on past promises, as is actually the case.

A downgrade of U.S. government debt would have unpredictable and highly disruptive consequences in financial markets and the broader economy.

Treasuries have long been used as a global safe-haven for investors shunning risky assets. They serve as a benchmark for market interest rates and investment portfolios.

Federal Reserve Chairman Ben Bernanke argued this week that failure to raise the statutory limit would have "calamitous" results, including a long-term loss of confidence in the United States and possibly a new financial crisis.

In Europe, meanwhile, euro zone leaders will meet on Thursday to discuss a second bailout package for Greece and the financial stability of the euro area.

With the region's fiscal problems now threatening Italy, the bloc's third largest economy, there is a pressing need on both sides of the Atlantic for bold, comprehensive solutions to debt problems.

Europe's latest round of bank "stress tests" appeared to calm some nerves as fewer institutions -- just eight out 90 -- failed than investors had expected. But confidence remained shaky, with many questioning the stringency of the criteria.

"You go to give yourself an exam, you prepare the questions, you answer them, and you grade them and say, 'Hey look, I'm pretty good!'" said John Brady, a futures trader at MF Global securities in Chicago.


As if the political hot-potato were not sufficiently worrying, a thin U.S. economic data calendar features primarily figures likely to show the country's housing market remains in a deep rut.

Existing home sales were seen rising modestly to around 4.9 million annualized units. Still, the level was a far cry from the bubble peaks of around 7.1 million, and still well below readings close to 6 million seen after a home-buyers tax credit was put into place last year.

Housing starts, too, are also expected to increase slightly, even if real estate activity is unlikely to rebound demonstrably any time soon. The June employment report, which pointed to a virtual stagnation of the job market in May and June, showed the construction sector was again shedding jobs.

A more forward-looking, if secondary, indicator is the Philadelphia Fed's index of Mid-Atlantic manufacturing. The index, among the first peeks into economic activity in the third quarter, is forecast to have returned to positive territory at 2.0 following a reading of -7.7 in June.

Many economists expect the recovery's pace to pick up in the last six months after a sluggish first half, but dismal employment data have cast doubt on that prognosis.