S&P Needs To Shut Up

S&P last night came out with a report that it could downgrade U.S. debt even if the debt ceiling is raised. S&P basically came out and said Congress needs to cut $4 trillion from the budget over the next 10 years, or a downgrade is likely. S&P and the other rating agencies are doing their job saying they are putting the U.S. government debt on negative watch. S&P said it wants a credible plan from Congress or it might downgrade U.S. debt, but giving a specific number ($4 trillion) is absurd. It is not the rating agencies job to play politics. John Chambers, the managing director of S&P is boxing himself in with the $4 trillion, despite the Mitch McConnell plan continuing to gain traction on Capitol Hill. He is playing policy maker with the $4 trillion number, and the fact that the rating agency, owned by The McGraw-Hill Companies, Inc. MHP has said that it might not wait until August 2 is forcing Congress' hands, is not their job. S&P has rated U.S. federal government debt at Aaa since 1941, and the fact that there is a 50% chance of a downgrade in 3 months is beyond absurd. S&P is allowed to have an opinion, but if Congress is working on getting a deal done, then there is no reason to downgrade the debt before something happens on Capitol Hill. If on August 3 there is no deal done, then it is acceptable to downgrade U.S. debt. All hell will break loose, but the rating agency will be doing its job. Playing politics and being essentially the fourth branch of legislation is not its job. Chambers is quoted as saying, "The debate has lasted longer & been more intractable than expected." We all agree with you that the debate should not have come so close to the deadline, especially with Congress needing to ratify the bills and approve of them, then hand them over to President Obama for his signature. What none of us agree with is the rating agencies, including Moody's MCO and Fitch now trying to make up for your mistakes during the financial crisis by jamming a potential downgrade down our throats. Looking at equity futures and bond yields, nobody really believes that a downgrade is imminent from S&P or the other rating agencies. There is a wall of worry on this issue, as we saw yesterday when the White House made comments that both sides had agreed to $1.5 trillion in cuts. The markets shot up on this headline, but those losses started to accelerate after it was realized that it was not a deal. If and when S&P does downgrade U.S. debt, the implications would be astronomical. The U.S. dollar would plunge against the Swiss Franc, bond yields would blow out, equities would crack, and investor confidence around the world would be badly shaken. Nobody wants to see that, especially in light of the financial crisis that happened just a few years ago. Still, as investors and traders, we need to be ready for this. So how to play this? ACTION ITEMS:

Bullish:
Traders who believe that a downgrade is not likely might want to consider the following trades:

• Go long everything. Names like Caterpillar CAT, MMM MMM and others are likely to jump on a deal getting done.

Bearish:
Traders who believe that a downgrade is likely may consider alternate positions:

• Going long the Swiss Franc ETF FXF could prove to be profitable, as inflows into the Swiss Franc would be heavy on a credit downgrade.

• PowerShares DB US Dollar Index Bearish UDN could also be a profitable trade, as the U.S. dollar will likely lose value on a credit event.

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