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Tags: Solution | Little | Late | europe | US

Any Solutions May Be Too Little, Too Late for EU, US

By    |   Monday, 24 October 2011 08:38 AM EDT

Bank of America-Merrill Lynch economists say the United States will lose its triple AAA credit rating status from another major credit rating agency, which should be Moody’s or Fitch, by year’s end if Congress fails to agree upon a credible long-term plan that addresses the U.S. deficit problem.

The so-called congressional super committee was tasked in May with finding $1.2 trillion in deficit reductions over the next 10 years, but where the number should be at least $3 trillion.

The committee’s deadline for a plan is in late November. I have no doubt whatsoever that, in case Merrill's North American economist Ethan Harris who wrote in the report is right, this would be an additional blow to the still extremely fragile U.S. economy that continues teetering on the brink of slipping back into recession.

Again, as a long-term investor, there is still no sound reason to get really optimistic on the U.S. yet.

The U.S. Conference Board recently released its Leading Economic Index (LEI). “The LEI is pointing to soft economic conditions through the end of 2011,” said Ken Goldstein, economist at the Conference Board.

“There is a risk that already low confidence — consumer, business and investor — could weaken further, putting downward pressure on demand and tipping the economy into recession. The probability of a downturn starting over the next few months remains at about 50 percent,” he said.

To me, that 50/50 chance of another downturn doesn’t give any assurance at all to start allocating “cash positions” now. The only thing we can do for now is hoping that the U.S. Conference Board is wrong in its assessment.

Nevertheless, the Conference Board’s view got some support on Friday when Federal Reserve Vice Chairman Janet Yellen said that a third round of large-scale securities purchases may be necessary to boost the economy and spur hiring.

A day before her statement, Fed Governor Daniel Tarullo said the Fed should consider resuming large-scale purchases of mortgage bonds to help combat the employment crisis. Tellingly, the residential real estate industry has aided every economic recovery since 1982 except this crisis that began in June 2009.

Maybe as investors, we should start to prepare ourselves for a world with less triple-A sovereigns. Standing apart from the pack is Germany, but besides them, even the best of the bunch are still in pretty poor fiscal shape.

And this brings us to Europe once again where there is, even after the EU summit yesterday in Brussels, no “real” solution in sight. Maybe a small detail that tells it all: Didier Reynders, the Belgian finance minister, left yesterday the EU summit early to attend the world premiere of the new Tintin film.

Maybe it should be helpful to keep in mind that the eurozone sovereign debt crises in the periphery countries is inextricably intertwined with weak banks throughout Europe where the boundaries between public sector and private sector finances have become more and more fluid while assets and liabilities have migrated.

So, despite talk of “significant progress” the final terms on bank recapitalization has now been re-scheduled for Wednesday, it now looks like the final European Banking Authority’s stress tests indicate that a total of 108 billion euros (US$150 billion) would be needed to allow EU banks to meet their core tier one 9 percent thresholds after marking to market their periphery debt holdings. Noteworthy is the fact that the IMF sees that number above 200 billion euros…

Interesting is the fact that German Chancellor Angela Merkel emphasized yesterday the need to “prepare properly” for “far-reaching decisions.”

It needs to be said that one factor for delaying “the” definitive rescue plan, which could probably become this week “a” rescue plan that will not be a final plan and will have to be readjusted afterward anyway, was resistance from, yes, Spain, Portugal and Spain in signing up to “any” plan before any agreement on leveraging up the eurozone’s bailout fund

While the EU cacophony continues unabated, the only thing we now know so far is that yesterday in Brussels they have agreed for more meetings that will be at least two, but probably three.

Probably the most important will be the European Council meeting of the 27 members, which include also the non-Eurozone members like the UK and Poland, just before Wednesday’s Eurozone summit. Britain and Poland who are the biggest non-eurozone EU members must feel good now they will be finally and directly invited at the negotiating table for the big decisions that will have to be taken by all EU members. If that will be of any help for coming up with a “real” rescue plan is another question.

Anyway, in my opinion, “whatever plan” that will be announced this week, it will the “too little, too late.” It will be interesting to see with what the EU will come up with at the G-20 meeting next week on Nov. 3 and 4 in Cannes, France.

I’m sorry, but as things are evolving now, and I’m speaking on both sides of the Atlantic, I really can’t turn confident that we’ll see a “trustworthy” light at the end of the tunnel in the weeks ahead. I don’t change my preference for “risk off” and I certainly don’t take part in these over-optimistic “yo yo” markets.

Maybe another warning sign comes today from the just released Markit Flash Germany PMI data that indicates German private sector growth maintained in October a marginal pace of expansion that was much slower than that seen during the first half of the year. The seasonally adjusted Markit Flash Germany Composite Output Index registered 51.2, up only fractionally from a 26-month low of 50.5 in September.

Maybe much more important, the new Markit Flash Eurozone PMI data shows the Eurozone downturn gathered momentum in October with manufacturing output falling for the third month running and services activity falling for the second month, both seeing rates of decline accelerate to the fastest since mid-2009.

Now it’s sure that EU banks will definitively have to recapitalize, a new EU credit crunch should be considered as a possibility.

No, that’s not good news.

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Bank of America-Merrill Lynch economists say the United States will lose its triple AAA credit rating status from another major credit rating agency, which should be Moody s or Fitch, by year s end if Congress fails to agree upon a credible long-term plan that addresses the...
Monday, 24 October 2011 08:38 AM
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