The Debt Dominoes Are Starting To Fall, But No One Cares Just Yet

Over the weekend, a ratings agency downgraded U.S. government debt. Fortunately or unfortunately, depending upon your perspective, no one cares what Egan-Jones has to think. The independent ratings agency run by Sean Egan downgraded the US from AAA to AA+ over the weekend. In the release, Egan-Jones said, "Real GDP increased at an annualized rate of 4.0% in Q1 2011, following an increase of 3.5% rise in the prior quarter. Personal consumption expenditures, exports, and nonresidential fixed investment contributed positively to growth during the quarter. Meanwhile, imports rose sharply. In the March 2011 quarter, trade in goods and services resulted in a deficit of $562B, many because of the high price of petroleum. However, the major factor driving credit quality is the relatively high level of debt and the difficulty in significantly cutting spending. We are taking a negative action not based on the delay in raising the debt ceiling but rather our concern about the high level of debt to GDP in excess of 100% compared to Canada's 35%. Nonetheless, since the US's debt is denominated in dollars, a hard default is unlikely." Since Egan-Jones is not Fitch, Moody's MCO, or S&P MHP, nobody really cares. There is some weight put on what Egan-Jones thinks, but since it is not a major ratings agency, it is brushed aside and swept under the rug by the media and Wall Street. If Congress can not get a debt ceiling done by this week or next week at the very latest, a U.S. debt downgrade is almost certain to destroy the confidence of investors around the world. The U.S. has had a Aaa rating since 1941, and the ramifications of losing it are a huge unknown and could cause mass chaos in the global financial markets. President Obama and the Democrats continue to meet with Republicans over the ceiling, even going so far as having talks at Camp David over the issue. Meetings have often been contentious, and have seen occasional walk outs and meetings ending abruptly. S&P even went so far last week as to say that $4 trillion needs to be cut from the federal deficit over the next 10 years, or a downgrade was still likely. Whether you agree with S&P or not is not the point, but the fact of the matter is that U.S. debt has been downgraded by a ratings agency because of Congress' inability to get a deal on the debt ceiling done. We've started to see traction on the Mitch McConnell plan, but nothing has come to a vote yet. A major ratings agency giving a credit downgrade to U.S. government debt could and probably would be catastrophic to the U.S. dollar, sending it sharply lower than it already is. Yields on U.S. debt would probably blow out, although you would not think that, looking at the current yields on debt now. Equities would spiral down and there would be chaos worse than the financial crisis of 2008, as we are even more intertwined now than we were three years ago. The dominoes have already started to fall. It's up to Congress to make sure that it's just one, and the whole line doesn't come crashing down. ACTION ITEMS:

Bullish:
Traders who believe that Egan-Jones is the last credit agency to downgrade U.S. debt might want to consider the following trades:

• Buying the Russell 2000 ETF IWM could be profitable, as stocks are likely to rally on news of a deal.

• High beta names like Baidu BIDU, Google GOOG and Apple AAPL should also do well.

Bearish:
Traders who believe that Egan-Jones is just the first to downgrade the U.S. may consider alternate positions:

• Go long the Swiss Franc ETF FXF as there will be a massive influx into this safe haven currency.

• Short every equity you can borrow.

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