Day Trader Matt

UNITED STATES

Policymakers in the world’s largest economy have undertaken large-scale measures on both the monetary and fiscal fronts since the Lehman collapse. Since lowering the Federal Funds Rate target to 0.00-0.25 percent in Nov. 2008, the Fed has launched asset purchases that have swelled its balance sheet to unprecedented levels. Fiscal efforts have focused on both project spending and tax cuts.

As of March 2012, the Fed has already completed both QEI and QEII. Operation Twist is ongoing; however, since purchases of longer-maturity Treasuries are being financed from sales of existing holdings, the program is not adding to the Fed’s balance sheet.

These programs have led to renewed confidence in the US banking sector, lower rates across the yield curve (including historically-low mortgage rates), and a recovery led by manufacturing. Despite signs of a pickup in economic activity, however, weak spots remain, with US home prices stagnant at best. Nonetheless, by signaling that it will hold off on further quantitative easing, the Fed appears to consider its pledge of low rates until late 2014 sufficient for sustaining the economic recovery.

EUROZONE

In the Eurozone, the bulk of stimulus efforts have been concentrated on the monetary side, as already large deficits and high debt-to-GDP ratios in many Eurozone countries, in addition to fiscal restrictions under the Stability and Growth Pact, ruled out the possibility of significant fiscal efforts. The two main monetary efforts focused on: (1) purchase of government debt issued by peripheral Eurozone nations and (2) longer-term loans to banks at low interest rates. In addition, Eurozone leaders have launched a number of bailouts for peripheral countries.

*Total capacity of FROB

The ECB’s unconventional measures – combined with Eurozone leaders’ efforts to push through a Greek debt swap and to introduce stricter budgetary rules – have led to some degree of improvement in market sentiment in Europe. Amid improved market confidence, the ECB is now considering suspending the SMP and has even resumed warnings about inflation. Growth remains moribund, however – even Germany’s economy contracted 0.2 percent in the 4th quarter of 2011 – implying that at least the existing loose policy will continue for the foreseeable future.

JAPAN

Faced with challenges ranging from disaster recovery to a strong Yen, both the Bank of Japan and fiscal authorities have shown a degree of coordination in their stimulus efforts. On the monetary side, Japan has both expanded existing asset-purchase programs and created new ones, especially in the wake of the March 2011 earthquake. The government has also responded in kind, crafting 4 special budgets to support post-disaster economic recovery. In addition to these initiatives, Japanese authorities have intervened at least 3 times in the currency markets in 2011 to shield exporters hurt by a strong Yen.

In response to these measures, the Japanese economy experienced strong growth in the 3rd quarter of 2011 but returned to contraction in the 4th. However, with the significant weakening of the Yen following the Bank of Japan’s latest expansion of its Asset Purchase Program in February 2012, growth could be expected to pick up again. Without signs of consistent, durable economic growth, however, more stimulus is conceivable.

UNITED KINGDOM

In the face of mounting budget shortfalls, and with the Cameron government’s commitment to deficit-reduction, direct fiscal stimulus in the UK has been modest. However, British taxpayers have spent or committed over half of the country’s annual economic output in bailing out some of the UK’s largest lenders, including Lloyds and Royal Bank of Scotland, which had come under pressure from souring real-estate loans. Meanwhile, the thrust of stimulus efforts has been the Bank of England’s Asset Purchase Facility.

*National Audit Office estimate Dec. 2009 – total amount spent or pledged

With no sign that the government is relaxing its commitment to deficit-cutting, and with UK unemployment still painfully high, there has been a general consensus within the BoE that loose monetary policy should continue to offset fiscal austerity. However, a split within the MPC appears to be emerging between supporters of a further increase to the APF – such as Adam Posen – and other Committee members, such as Martin Weale, who warn that inflation could be more persistent than expected.

CHINA

Immediately following the collapse of Lehman Brothers in Sept. 2008, Chinese policymakers launched a 4-trillion Yuan stimulus package aimed mostly at infrastructure projects. However, authorities in the world’s second-largest economy also provided further stimulus by directing state-owned banks to increase lending, leading to new loans of at least 8 trillion Yuan in both 2009 and 2010.

Since the stimulus package, there have been signs of asset bubbles in the financial and real-estate markets, leading Chinese policymakers to pursue tighter policy – including interest-rate hikes and reserve-requirement increases – for much of 2011. Now, amid signs of an export and consumption slowdown and with inflation under the government’s 4-percent target, policymakers have undone some of the tightening. Future policy will continue to strike a delicate balance between several, often conflicting objectives, including controlling inflation, mitigating economic slowdowns, and preventing asset-price bubbles.

CANADA

With a banking sector largely untarnished by the financial crisis and an economy that recovered relatively robustly on the back of strong demand for commodities, stimulus in Canada has been limited. Aside from cutting rates to as low as 0.25 percent, the Bank of Canada has avoided further action. On the fiscal side, the Harper government launched the Economic Action Plan in early 2009.

Further stimulus in Canada remains unlikely despite consistently disappointing job creation in recent months. High oil prices and an improving economic picture in the United States is expected to continue to support the Canadian economy, obviating the need for any extraordinary stimulus measures. In addition, the government remains committed to budget cuts with the goal of re-achieving a balanced budget by fiscal year 2015-2016.

AUSTRALIA & NEW ZEALAND

With healthy banking sectors, economies supported by commodities demand from China, and scope for additional interest-rate cuts, the two South Pacific nations have largely avoided unconventional monetary policy. The main noteworthy fiscal effort was the Rudd government’s package of project spending, rebates, and bonus in 2009, which helped Australia become one of the few major economies to avoid a recession in 2009.

Despite signs that the strong Aussie is affecting employment in manufacturing and non-mining sectors of the economy, conditions in either country are still far from warranting large-scale stimulus. In addition, both Australia and New Zealand have set balanced- budget goals, for 2013 and 2015, respectively. As a result, interest rates will remain the primary tool of policy adjustment.

SWITZERLAND

Switzerland’s efforts have mainly focused on combating the strength of the Franc and the looming deflation threat. Its efforts have taken place primarily through the Swiss National Bank, and have ranged from foreign-currency purchases – 54 billion Francs in 2011 alone – to setting an exchange-rate floor for the Franc versus the Euro.The SNB has also increased sight deposits – a proxy for liquidity in the Swiss financial system – to 200 billion Francs.

The discussions surrounding further action by Swiss policymakers remains focused on the possibility of an even higher exchange-rate cap and of negative interest rates. At its most recent policy meeting in March, the SNB provided few hints of any plans to introduce such measures, but the Swiss central bank has surprised market in the past.

Sweden was the first European country to introduce bank notes in 1661. Now it’s come farther than most on the path toward getting rid of them.

“I can’t see why we should be printing bank notes at all anymore,” says Bjoern Ulvaeus, former member of 1970′s pop group ABBA, and a vocal proponent for a world without cash.

The contours of such a society are starting to take shape in this high-tech nation, frustrating those who prefer coins and bills over digital money.

In most Swedish cities, public buses don’t accept cash; tickets are prepaid or purchased with a cell phone text message. A small but growing number of businesses only take cards, and some bank offices — which make money on electronic transactions — have stopped handling cash altogether.

“There are towns where it isn’t at all possible anymore to enter a bank and use cash,” complains Curt Persson, chairman of Sweden’s National Pensioners’ Organization.

He says that’s a problem for elderly people in rural areas who don’t have credit cards or don’t know how to use them to withdraw cash.

The decline of cash is noticeable even in houses of worship, like the Carl Gustaf Church in Karlshamn, southern Sweden, where Vicar Johan Tyrberg recently installed a card reader to make it easier for worshippers to make offerings.

“People came up to me several times and said they didn’t have cash but would still like to donate money,” Tyrberg says.

Bills and coins represent only 3 percent of Sweden’s economy, compared to an average of 9 percent in the eurozone and 7 percent in the U.S., according to the Bank for International Settlements, an umbrella organization for the world’s central banks.

Three percent is still too much if you ask Ulvaeus. A cashless society may seem like an odd cause for someone who made a fortune on “Money, Money, Money” and other ABBA hits, but for Ulvaeus it’s a matter of security.

After his son was robbed for the third time he started advocating a faster transition to a fully digital economy, if only to make life harder for thieves.

“If there were no cash, what would they do?” says Ulvaeus, 66.

The Swedish Bankers’ Association says the shrinkage of the cash economy is already making an impact in crime statistics.

The number of bank robberies in Sweden plunged from 110 in 2008 to 16 in 2011 — the lowest level since it started keeping records 30 years ago. It says robberies of security transports are also down.

“Less cash in circulation makes things safer, both for the staff that handle cash, but also of course for the public,” says Par Karlsson, a security expert at the organization.

The prevalence of electronic transactions — and the digital trail they generate — also helps explain why Sweden has less of a problem with graft than countries with a stronger cash culture, such as Italy or Greece, says economics professor Friedrich Schneider of the Johannes Kepler University in Austria.

“If people use more cards, they are less involved in shadow economy activities,” says Schneider, an expert on underground economies.

In Italy — where cash has been a common means of avoiding value-added tax and hiding profits from the taxman — Prime Minister Mario Monti in December put forward measures to limit cash transactions to payments under euro1,000 ($1,300), down from euro2,500 before.

The flip side is the risk of cybercrimes. According to the Swedish National Council for Crime Prevention the number of computerized fraud cases, including skimming, surged to nearly 20,000 in 2011 from 3,304 in 2000.

Oscar Swartz, the founder of Sweden’s first Internet provider, Banhof, says a digital economy also raises privacy issues because of the electronic trail of transactions. He supports the idea of phasing out cash, but says other anonymous payment methods need to be introduced instead.

“One should be able to send money and donate money to different organizations without being traced every time,” he says.

It’s no surprise that Sweden and other Nordic countries are at the forefront of this development, given their emphasis on technology and innovation.

For the second year in a row, Sweden ranked first in the Global Information Technology Report released at the World Economic Forum in January. The Economist Intelligence Unit also put Sweden top of its latest digital economy rankings, in 2010. Both rankings measure how far countries have come in integrating information and communication technologies in their economies.

Internet startups in Sweden and elsewhere are now hard at work developing payment and banking services for smartphones.

Swedish company iZettel has developed a device for small traders, similar to Square in the U.S., that plugs into the back of an iPhone to make it work like a credit card terminal. Sweden’s biggest banks are expected to launch a joint service later this year that allows customers to transfer money between each other’s accounts in real-time with their cell phones.

Most experts don’t expect cash to disappear anytime soon, but that its proportion of the economy will continue to decline as such payment options become available. Before retiring as deputy governor of Sweden’s central bank, Lars Nyberg said last year that cash will survive “like the crocodile, even though it may be forced to see its habitat gradually cut back.”

Andrea Wramfelt, whose bowling alley in the southern city of Landskrona stopped accepting cash in 2010, makes a bolder prediction: She believes coins and notes will cease to exist in Sweden within 20 years.

“Personally I think this is what people should expect in the future,” she says.

But there are pockets of resistance. Hanna Celik, whose family owns a newspaper kiosk in a Stockholm shopping mall, says the digital economy is all about banks seeking bigger earnings.

Celik says he gets charged about 5 Swedish kronor ($0.80) for every credit card transaction, and a law passed by the Swedish Parliament prevents him from passing on that charge to consumers.

“That stinks,” he says. “For them (the banks), this is a very good way to earn a lot of money, that’s what it’s all about. They make huge profits.”

China reported its biggest monthly trade deficit in at least a decade in February as imports rebounded after a Lunar New Year holiday slowdown, but a broader measure showed global and Chinese demand both weakening.

Exports grew 18.4 percent over a year earlier to $114.5 billion, up from a 0.5 percent contraction in January, when factories were idled for a two-week holiday break, customs data showed Saturday. Imports jumped 39.6 percent to $145.9 billion, reviving after the previous month’s 15 percent decline.

China’s global trade deficit was $31.5 billion — the biggest since at least the 1990s and a rare exception to a recent string of multibillion-dollar surpluses.

The deficit reflected China’s relatively strong growth amid Europe’s debt crisis and U.S. economic troubles. The economy expanded by 8.9 percent in the final quarter of 2011 and the government’s growth target this year is 7.5 percent.

But a broader measure, combining February’s strong showing with the January slump, showed growth in both imports and exports decelerating markedly.

January-February export growth slowed to 6.9 percent over the same two-month period last year, barely half of December’s 13.4 percent rate. Imports for the two months rose 7.7 percent, down from December’s 11.8 percent.

Analysts look at the combined period to offset the impact of the Lunar New Year, which comes at different times in January or February each year, distorting trade figures as producers rush to fill orders before closing for two weeks or more.

Chinese demand for oil, iron ore, other commodities and industrial components has cooled as export-driven factories see orders fall and Beijing tries to steer its overheated expansion to a sustainable level.

China often records a trade deficit for one month early in the year as factories restock after the holiday, but rarely as large as February’s. Last year, the only monthly deficit was $7.3 billion in February, while surpluses hit a high of $31.5 billion in July.

January’s trade declines were the sharpest since the 2008 global crisis.

China is one of the biggest importers and the top export market for many of its Asian neighbors and commodity suppliers as far away as Australia and Africa, which means cooling demand could have global repercussions.

The International Monetary Fund is forecasting 8.2 percent growth this year but has warned that could fall by as much as half if Europe, China’s biggest export market, suffers a severe decline in activity due to its debt woes.

Exports to the 27-nation European Union contracted by 1.1 percent in February from a year earlier to $19.4 billion, the General Administration of Customs of China reported. China’s trade surplus with Europe contracted by 79 percent to $1.6 billion.

Despite the surge in imports, China’s politically sensitive trade surplus with the United States rose by 1 percent to $8.1 billion.

S&P downgrade the European Financial Stability Facility (EFSF) to ‘AA+’ from ‘AAA’. The move raises another barrier to a rescue of the weakest nations in the region. It combines with the S&P downgrade of nine nations’ sovereign debts, which included France’s, and a dramatic series of breaks in discussions between private investors and the Greek government.

The pessimism about the future of Greece and the ability of major nations to raise capital at reasonable rates should rise substantially, and such an increase would be appropriate. There is risk of another cut in the fund’s rating if nations in the region receive another series of downgrades.

As part of the announcement, S&P reported

“Following the lowering of the ratings on France and Austria, the rated long-term debt instruments already issued by the EFSF are no longer fully supported by guarantees from the EFSF guarantor members rated ‘AAA’ by Standard & Poor’s, or ‘AAA’ rated liquid securities. Instead, they are now covered by guarantees from guarantor members or securities rated ‘AAA’ or ‘AA+’.
We consider that credit enhancements that would offset what we view as the now-reduced creditworthiness of the EFSF’s guarantors and securities backing the EFSF’s issues are currently not in place. We have therefore lowered to ‘AA+’ the issuer credit rating of the EFSF, as well as the issue ratings on its long-term debt securities.”

The EFSF’s credit worthiness is backed by 14 nations within the eurozone. Each of these is believed not to need support to continue to raise capital for deficit financing and general needs.

As The Wall Street Journal points out

“Without France and Austria, the sum of triple-A guarantees falls from €451 billion ($572 billIon) to €271 billion, more than three-quarters of which comes from Germany.”

Many analysts say that a near-simultaneous bailout of Portugal, Ireland, Greece, and Italy would require a fund of nearly $1 trillion. Much of the money would have to come from Germany. And, Germany may have lost its will to be the de facto bank for Europe. This is particularly true if its leaders believe that the drops in GDP in the weakest nations has accelerated more rapidly than expected and that deficits will rise accordingly. Some economists argue that even with German money that that the austerity requirements that come with bailout dollars by their nature withdraw needed stimulus in countries which have unemployment well into the double digits

It has only taken a few days for the sovereign problems in Europe to go from what appeared to be manageable to the brink of a catastrophe

The ECB loan program will extend credit out to 3 years at the average of the ECB’s benchmark rate (currently at 1%) to $645 billion today. This was much larger than expected, but not very surprising. With the ECB likely to keep rates low for an “extended period of time” (the U.S. Feds chosen words, not the ECB’s at least publically), the money represents virtually fixed liquidity at a low 1% yield or less if the ECB cuts more. Banks decided to take the money and run.

So where can they run to? That depends on who you are and how you are preceived by your fellow banks. If you are considered at risk, taking the money solves a liquidity problem. If you are not considered a risk, the money helps recapitalize your bank. There are other benefits to the “at risk” economies like Spain and Italy, if the cards play out properly.

Below are how I see each shaping up.

Banks with Liquidity Concerns: Banks who have liquidity issues will be able to use the funds and not have to worry about securing funds in the interbank market. This will prevent a run on the bank should there be a worry about funding by depositors. It also takes them away from the capital markets where they would likely have to pay a higher rate than 1% for 3 years. It buys these banks time to get their house back in order. Moreover, counterparties who are reluctant to lend now to the troubled institutions- even on a shorter term basis – might be inclined to open up some lending lines to them. This is good and a sigh of relief for those institutions.

Banks without Liquidity Concerns: Banks who do not have liquidity issues can take the cheap funds and apply it in the market. For example, they could venture in shorter term debt market of Spanish and Italian notes – say 2 years. Italy has a Long Term credit rating of A2 from Moody’s and Spain has a rating of A1. It is not AAA but it still is acceptable.

The 2 year yield on Italian bonds are at 5.223% while the 2 year yield on Spanish bonds are at 3.62% (see chart below). An average of the two countries comes to 4.4215%. Banks could purchase these notes with the 1% funds and earn carry profits of 342 basis points. Not a bad return.

Is this not similar to what the US banks did when the Fed embarked on their QE program (by the way QE2 was for $600 billion – very similar to the 645 billion today).

When the Fed’s QE program was enacted, banks got the wink from the Fed that rates were to stay low for an extended time period, took the free money, invested in Treasuries, forced the yields down, earned risk free carry profits which boosted capital. They paid off their loans from the Fed and are now in a better financial situation because of it. They could do this because the economy was deleveraging with little risk of inflation sticking.

This is what the ECB may be looking to replicate as they force austerity measures (deleveraging) which will slow growth in 2012. The difference is the ECB can not embark on QE. They are looking instead for the banks to do the QE for them by giving them money, a wink that rates will remain low (and may even decline further) and in effect giving them the AOK to buy Spain and Italy debt. Greece is a separate case but manageble.

Is that play risk free? No. MF Global found that out the hard way with their bet on Italian bonds. However, the story has changed since that time of their demise, with the support from the ECB, the lowering of rates and the likely scenario that rates will stay low for an extended period of time. It is too early to tell, but MF Global may have been a month away from hitting a home run on their risky bond position. The fact is, however, they were overextended at the wrong time, did not understand or define their risk and when the run was on, they compounded their problems. They also were the loan wolf on their bet. Others were concerned about the risk and getting rid of risky assets whether right or wrong. They went at it alone. It is never good to tell “the market” what to do. The market may not agree with your assessment. It is always better to follow “the market”. If the banks take the money and continue to invest in debt of the likes of Italy and Spain, it should turn the tide and take out even more of the risk premium. Sentiment moves the market, and the sentiment may be changing.

So what are the financial gains? The down and dirty of taking $645 and earning a carry spread of 342 basis points in a relatively risk free 2 year debt, yields a return of $22 billion for year one, 44 billion for two years and 66 bilion for three years. It also should lower the cost of borrowing for the likes of Spain and Italy which will allow them to rollover massive amounts of debt in 2012. Looking at the chart below, the borrowing cost in the 2 year sector is already down over 200 basis points. PHEW!!!! That’s real money.

Banks are better off today. The likes of Spain and Italy (which are the main worries in the market) are better off today. Moreover, if they need to do more down the road, the ECB can simply do another tranche.

The risk is the liquidity will re-ignite growth and with it inflation. This is not likely, however, with the pressure put on austerity and the deleveraging that will likely continue to take place. If the economies do not deleverage, that will be a problem, but most think the opposite will occur.

This is a good thing and likely the only thing that could have been done. The firepower has been enacted and the process is started.

First, do no harm. That is a useful injunction for doctors, lawyers, and, it turns out, U.S. presidents.

But President Obama’s useless speech Monday about the basic soundness of the American economy managed to reinforce all the concerns Americans on the left and right have about his stewardship of the country.

The speech did at least temporary harm. As soon as he finished speaking, the already jittery financial markets plunged.

Americans didn’t want to hear that we’re fine people or that Warren Buffett thinks that we should have an impeccable credit rating.

They didn’t want him to repeat his basic talking points: the need to marshal the “political will” to extend the payroll tax cut and unemployment insurance benefits, or create an infrastructure bank.

They didn’t want to hear his perfectly reasonable desire to solve the debt crisis over time by cutting spending after the economy recovers and by raising more revenue from what the president now calls “tax reform” rather than new taxes.

Americans wanted to hear what President Obama was planning to do to create jobs and stop our economy from slipping over an economic abyss into a double-dip recession.

His calm, passionless, “voice of reason” message, without a single new proposal except his pledge to make specific proposals in the future and work with the Congressional designated super-committee to address the deficit and debt crises – “leading from behind again” – actually panicked the markets. And no wonder. Americans were looking for a leader, and what we got was the professor again.

One must sympathize with the president. Last week was his worst week ever in the job.

First, he turned 50, usually traumatic for most people, even politicians.

Then he became the first president to have a downgrading of America’s credit worthiness on his watch – an action taken by Standard & Poor’s, a company that made a two trillion dollar mistake in its own budget calculations and which gave the highest credit rating to Lehman Brothers on the verge of bankruptcy and to the mortgage-backed securities that helped cause the 2008 financial crisis. How do you spell “chutzpah” on Wall Street?

Then he presided over the deadliest day in Afghanistan – the loss of 30 Americans soldiers, most of them Navy Seal commandos, some from the same unit that killed Osama Bin Laden. (He lauded their courage and sacrifice in the only convincing part of his today’s speech – at the end of that speech, which he introduced with the world’s most awkward transition: “One More Thing.”)

Then markets plunged.

The president has now managed to deepen the alienation of the right – who rightfully accuses him of being a free-wheeling tax and spender whose profligacy is responsible for the nation’s slow growth and falling credit worthiness.

Now, the left of his party, too, is in full rebellion. On Sunday, Drew Westen, a professor of psychology at Emory, articulated the fury of liberal Democrats in a New York Times Sunday Review essay.

He excoriated Obama for failing to provide a “counternarrative” to that of the right and for engaging in “the politics of appeasement” with the Tea Party. The public, he wrote, was desperate for a Roosevelt who would name names and assign blame – to his predecessors. (Hasn’t Obama done a lot of that?) Instead, it got more rhetoric. Instead of indicting his predecessors’ economic policies that had eliminated eight million jobs, “in the most damaging of the tic-like gestures of compromise that have become the hallmark of his presidency,” Westen wrote, “he backed away from his advisers who proposed a big stimulus, and then diluted it with tax cuts that had already been shown to be inert.” The predictable result was a “half-stimulus that half-stimulated the economy.”

How can one explain this lack of leadership? Westen offered several harsh theories. Perhaps Obama is, as conservatives have alleged, too inexperienced and hence, incompetent. Obama, he wrote, “had accomplished very little before he ran for president, having never run a business or a state.” He had a “singularly unremarkable career as a law professor, publishing nothing in 12 years at the University of Chicago other than an autobiography.” Finally, before joining the Senate, he had voted “present” rather than “yea” or “nay” 130 times, “sometimes dodging difficult issues.”

But wait. Westen has an even harsher explanation, namely that America is being “held hostage not just by a president who either does not know what he believes or is willing to take whatever position he thinks will lead to his re-election.”

Ouch. No wonder Mr. Obama looked so very shaken during a speech that was intended to boost the nation’s confidence.

The people who were talking about Sarah Palin’s lack of experience during the 2008 elections are now voicing concern over the apparent lack of Obama’s experience. I wonder if they would change their vote if they had a time machine?

The United States lost its top-notch triple-A credit rating from Standard & Poor’s Friday, in a dramatic reversal of fortune for the world’s largest economy.

S&P cut the long-term U.S. credit rating by one notch to AA-plus on concerns about growing budget deficits.

“The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics,” S&P said in a statement.

“More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011,” the statement said.

The outlook on the new U.S. credit rating is negative, the S&P said in its statement, a sign that another downgrade is possible in the next 12 to 18 months.

On Aug. 2, President Barack Obama signed legislation designed to reduce the fiscal deficit by $2.1 trillion over 10 years. But that was well short of the $4 trillion in savings S&P had called for as a good “down payment” on fixing America’s finances.

The political gridlock in Washington and the failure to seriously address U.S. long-term fiscal problems came against the backdrop of slowing U.S. economic growth and led to the worst week in the U.S. stock market in two years.

“I did not expect this to happen this soon. This is something they gave the criteria on and I guess they stuck to it,” said George Goncalves, chief Treasury strategist for Nomura Americas. “I really thought they’d take the two-stage approach and see how further cuts would come along.”

This came after a confusing day of reports: Standard & Poor’s told the U.S. government early Friday afternoon that it was preparing to downgrade the U.S.’s triple-A credit rating but U.S. officials notified S&P that it had made a $2 trillion mathematical error.

The error was in the calculation of the U.S. debt-to-GDP ratio over time and was based on a misreading of what the correct congressional baseline was, government sources indicated. They said that once informed of the error S&P revised its rate-cut rationale to emphasize the political aspects of the country’s debt situation.

“A judgment flawed by a $2 trillion error speaks for itself,” a Treasury spokesperson said.

Throughout Friday, markets were rife with speculation that S&P, which has had a negative outlook on the U.S. since April 18, would downgrade the country’s credit from its current triple-A level and that it could come as early as Friday night.

Goncalves said the downgrade could hit market confidence.

U.S. Treasurys, once undisputedly seen as the safest investment in the world, are now rated lower than bonds issued by countries such as the UK, Germany, France or Canada.

On July 14, S&P put the government on a credit watch with negative implications, meaning there was at least a one in two chance the U.S.’s long-term debt would be downgraded within 90 days.

Earlier Friday an S&P spokesman declined to comment on any possible plans for a downgrade or statement.

On Tuesday, both Fitch and Moody’s backed their triple-A rating on the U.S.—but with caveats.

Fitch warned that the U.S. rating “will remain under pressure for some time,” while Moody’s ) ] went so far as to slap the U.S. with a negative outlook.

Congressional leaders have reached an agreement on raising the US debt limit, President Barack Obama has announced.

The deal will cut about $US1 trillion in spending over 10 years and will prevent the first government default in US history.

President Obama announced the deal after congressional leaders met late into the night.

“The leaders of both parties in both chambers have reached an agreement that will reduce the deficit and avoid default,” President Obama said. “This compromise does make a serious downpayment on the debt reduction we need.”

Congressional leaders are sifting through the details of the tentative bipartisan agreement to raise the debt ceiling, preparing to sell the deal to skeptical Republicans and Democrats ahead of possible votes tomorrow.

Despite Senate Majority Leader Harry Reid’s objections Republican leaders and the Obama administration worked out the final details.

Senate Minority Leader Mitch McConnell, a key member in the debate, told senators that the US will not default on its obligations.

The framework would raise the $14.3 trillion debt ceiling through 2012, cut spending by about $1 trillion and call for enactment of a law shaving another $1.5 trillion from long-term debt by 2021 — or institute punishing reductions across all government areas, including Medicare and defense programs, according to congressional officials.

The White House and lawmakers have been hunting for an agreement that would raise the $14.3 trillion dollar US debt ceiling while making deep spending cuts aimed at reining in the galloping US budget deficit.

The US economy hit its debt limit on May 16 and has used spending and accounting adjustments, as well as higher-than-expected tax receipts, to continue operating normally — but can only do so through midnight Tuesday.

Business and finance leaders have warned default would send crippling aftershocks through the fragile US economy, still wrestling with stubbornly high unemployment of 9.2 percent in the wake of the 2008 global meltdown.

Without a deal, the US government would have had to cut an estimated 40 cents out of every dollar it spends, forcing grim choices between defaulting or cutting back programs like those that help the poor, disabled and elderly.

Where does the US debt impasse stand now that the “grand bargain” has gone into the great dustbin? Well, we have 2 competing versions – one led by the Republicans in the House, the second led by the Democrats in the Senate.

The 2 versions are pretty clear in that one tries to move the US beyond the crisis, while the other wants to revisit this issue in half a year’s time. Because it’s been so much fun to watch so far and who wouldn’t want to repeat this process in half a year.

Here are the possible options as they are being drawn up right now:

Reid Plan:

First, if you are tired of this debate, and want to see the US move onto solving other key issues, and put this debt ceiling debate behind us, at least until after the 2012 election, then the plan being written up by Harry Reid in the Senate sounds like the one for you.

From NYTimes: “Mr. Reid, the Senate’s top Democrat, was trying on Sunday to cobble together a plan to raise the government’s debt limit by $2.4 trillion through the 2012 elections, with spending cuts of about $2.7 trillion that would not touch any of the entitlement programs that are dear to Democrats or raise taxes, which is anathema to Republicans.”

No entitlements would be cut in this version, and roughly $1 trillion would be saved by winding down the wars in Iraq and Afghanistan. Another $500 billion would come from interest savings.

Boehner Plan

On the other hand, if you enjoy the political fighting and just can’t wait to do this whole shindig again, not to mention in between the battle for the FY12 spending bill, we have Boehner’s GDP short-term fix.

Again, from NYTimes: “The contours of Mr. Boehner’s backup plan were not entirely clear, but it seemed likely to take the form of a two-step process, with about $1 trillion in cuts, an amount the Republicans said was sufficient to clear the way for a debt limit increase through year’s end. That would be followed by future cuts guided by a new legislative commission that would consider a broader range of trims, program overhauls and revenue increases.”

“The preferable path would be a bipartisan plan that involves all the leaders, but it is too early to decide whether that’s possible,” Mr. Boehner said in a “Fox News Sunday” interview. “If that’s not possible, I and my Republican colleagues in the House are prepared to move on our own.”

The 3rd option is that neither of these proposals can pass both houses of Congress and the US hits the debt ceiling on August 2nd, or thereabouts, and the President has to decide whether to let the country fail on its obligations or he can use the 14th amendment to simply ignore the debt ceiling.

That option, while avoiding default will certainly bring cries of tyranny!

It doesn’t really make sense to me that after voting for the spending already, Congress has to vote a second time to authorize the debt ceiling to be raised – to pay for the stuff that has already been appropriated – but hey that’s Washington for you.

Nothing like playing politics with the future of the US credit rating..

Impact on the USD:

The Reid plan attempts to cut more from the deficit and avoids having political fights and uncertainty dragging down the US economy the rest of the year. However, since it doesn’t touch entitlements and doesn’t raise new revenue, credit rating agencies can still threaten and go ahead and actually downgrade the US credit rating.

The Boehner plan does very little beyond avoiding default in the very short term, and brings this whole charade back in half a year’s time. It also carried the threat of a Presidential veto, which if it is the way we go, can increase the tension in financial markets, bringing down the USD at the expense of other safe havens like the CHF and JPY, while also likely causing a sell off in equities and commodities.

The option of Obama ignoring the debt ceiling will infuriate Republicans and cause them to want to not work with him on anything and work towards his failure. So, that would pretty much put us exactly where we are currently. While it can make Obama look decisive, it also undermines credibility of the democratic process and he has said he would not consider this option. The impact on the markets would not be good for the USD as it would mean that the debt ceiling was increased without any significant plan put forward by Congress to cut deficits and debt.

Let’s see where we stand tomorrow, and which plan – Reid or Beohner – progresses faster through the Congress.

The Euro-zone stress tests have been revealed and the results are likely better than expected as only 8 banks failed the stress tests.
Here are some details:

• Out of those 8 banks – 5 Spanish, 2 Greece, 1 Austrian failed.
• 16 banks passed the tests “narrowly.”
• €2.5 billion of capital needs to be raised.
• Under the adverse scenario, the banks would lose €400 billion which represents 40% of core capital.

Here is the Summary Report from the EBA:

Here’s their highlights:

• Based on end 2010 information only, the EBA exercise shows that 20 banks would fall below the 5% CT1 threshold over the two-year horizon of the exercise. The overall shortfall would total EUR26.8 bn.
• However, the EBA allowed specific capital actions in the first four months of 2011 (through the end of April) to be considered in the results. Banks were therefore incentivised to strengthen their capital positions ahead of the stress test.
• Between January and April 2011 a further amount of some EUR50bn of capital was raised on a net basis.
• Once capital-raising actions in 2011 are added, the EBA’s 2011 stress test exercise shows that eight banks fall below the capital threshold of 5% CT1R over the two-year time horizon, with an overall CT1 shortfall of EUR2.5bn. In addition, 16 banks display a CT1R of between 5% and 6%.

The EUR crosses were mildly positive in the 5 minutes after the release, but the EUR/USD after testing 1.4188, fell back down to where it was trading before the release.

The low figure that will be needed to be raised is much below the expectations of the market, which was pegging a figure between €20 billion – €35 billion.

That can create some concern in regards to the validity of the tests, and we will be looking at the 16 banks that passed narrowly – and the market may as well – as banks that are on the edge.. That would bring the total number of banks that would be in serious trouble at 24, also what the market was expecting ahead of the report.

The devil will be in the details, so it may take some time to digest the report before the EUR takes a decisive direction.

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