The US ratings agencies, long discredited for kow-towing to the major Wall Street investment houses, as they led a race to the bottom in terms of assigning ratings to sophisticated and complex instruments they themselves were not able to fully understand, finally peered over the fiscal precipice on Monday with Standard & Poors opening the first salvo to admonish the US sovereign credit rating. It cut its long-term outlook on the US to "negative" from "stable." The revision sparked fears that Uncle Sam could soon surrender his coveted "AAA" rating, the cornerstone of "reserve currency" status.
I've always seen these firms as lagging indicators to the machinations in the real economy. Look at what happened in the Eurozone with Greece, Ireland and Portugal. They were late...as usual...in recognising the gargantuan sovereign fiscal risks. Maybe they don't see it as part of their remit anymore to stand up to and ruffle governments' feathers before fiscal road accidents happen. It used to be said the role of the Federal Reserve was to take away the punch bowl just as the party got swinging...with the independent ratings agencies jousting alongside in tandem. However, the pressure within these agencies to search for new sources of income compromised their high ethical standards in the quarterly earnings pressure-cooker that is Wall Street.
For most of 2011, long-term bond yields have been in a trading range between 4.375% and 4.65%. Despite the upward trajectory of QE2 money printing, an endless stream of Treasury bonds issuance and foreign buyers starting to make noises about US fiscal irresponsibilty (Brazil, Russia and China) and the Government's ability to repay, yields have remained stubbornly low.
But interest rates will have to go higher soon...the Treasury has to offer attractive yields to appeal to these overseas buyers to buy ever higher volumes. In February, PIMCO, led by bond king Bill Gross, a conservative bond stalwart, announced its exit from the US treasury market completely. That's akin to Burger King declaring they no longer will use beef in their burgers.
The opportunity to short the treasury bond market is not far off, with yields near the lowest points and pricing near the top of their trading ranges. QE2 ends on 30th June and will open up uncertainty as the market addicts develope cold turkey. Where else can one find the grease to ramp up the markets? A lucrative ETF, ProShares UltraShort 20+ Year Treasury (symbol NYSE: TBT) is a good proxy to brace for a decline in treasury prices, gaining 2% for each 1% fall in price.
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