Just How Likely Is A U.S. Downgrade?

This morning, S&P again reiterated its call for a U.S. debt downgrade sometime in the next three months. The New York-based ratings agency said that there is a 50% chance it will lower the U.S. credit rating from Aaa, where it has been for 70 years. This comes as worries persist that Congress will not be able to reach a deal that satisfies bond markets, rating agencies on curtailing the fiscal deficit and raising the nation's debt ceiling. S&P last week came out and said that Congress needs to cut $4 trillion from the budget over the next decade, or it will cut its Aaa rating by at least one notch, perhaps more. The "Gang of 6" plan is short on details, but long on hope, and would cut $3.7 trillion from the deficit, though S&P has not weighed in on whether that would be enough to stave off a credit downgrade. At the end of the day, it is looking more and likely that there will be some kind of downgrade, as the deadline for a deal set forth by President Obama is tomorrow, and so far we have nothing concrete to show for it. Congress is expected to be in session over the weekend, but that does not mean that anything will get done by then either. John Chambers, the managing director of S&P, boxed himself in with the $4 trillion number, essentially forcing S&P, owned The McGraw-Hill Companies, Inc. MHP to downgrade the debt. Chambers was quoted as saying, "The debate has lasted longer & been more intractable than expected." If you look at equities, bonds and commodities, nobody, and I mean NOBODY believes that something will happen in terms of a downgrade of U.S. debt. This could be construed as wrong, as politicians have nothing to show for their work, except some short term debt limit increases and S&P, Moody's MCO and Fitch have already said that will not prevent a downgrade. If, and when we do see a downgrade, chaos is likely to ensue. Even the Federal Reserve is planning for a U.S. default, and that should tell you something. At some point, the market is going to care, and when it does, it will be in a big way. Stocks react to whatever headline out of Europe we see, but they really should be focusing on what is going on at home. Precious metals are focusing on the issue, with gold and silver continuing to make new highs seemingly every day. Gold is near $1,600 an ounce, and threatening to go to $1,900 an ounce by October, at least if you believe John Taylor of FX Concepts. I try to be optimistic about no downgrade, but everyday it looks more and more like it is going to happen. Having said that, investors need to plan accordingly and prepare for the worst, but hope for the best. ACTION ITEMS:

Bullish:
Traders who believe that S&P really will downgrade U.S. debt might want to consider the following trades:

• Go long precious metals. Gold, and silver should do well. Consider ETFs like SPDR Gold ETF GLD or iShares Silver Trust ETF SLV.

• Short the U.S. dollar. If there is a credit downgrade, the dollar is likely to get crushed. Proshares U.S. Dollar UUP will plunge in value.

Bearish:
Traders who believe that S&P is bluffing and nothing will happen may consider alternate positions:

• Buy everything. If a deal gets done and there is no downgrade, there is likely going to be a relief rally. Consider buying the S&P 500 ETF SPY or the Russell 2000 ETF IWM.

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