El-Erian: US will be downgraded in a few days by S&P

He says this is a technical down grade and the world is constructed on the triple-A of US Treasuries and nobody knows what happens thereafter. He thinks it is definitely severely negative for equities. I wonder what will change S&P's mind, surely political pressure will be there, but El-Erian says if S&P examines the conditions proposed when it issued its negative outlook for US, US should be down graded within a few days. S&P also put a negative outlook on Fannie Mae and Freddie Mac last spring.

http://money.cnn.com...risis.cnnmoney/

I thought US would not be down graded no matter what happens from here, but then I also think about the consequences of a down grade. Technically, it should mean very little for US Bonds honestly, an equity sell off would still make the bonds more attractive. But the faith of USD will likely continue to remain down though and this means the bonds would also be sold some more.

However, the equities would be also sold further, if the bonds continue to sell, and USD bleeding would stop due to increasing demand for cash. This process would repeat a few times since people all around the world may demand a different currency and even worse the nations start dropping USD from their reserve currency --welcome WW3. So, unless USD continues to weaken, any pressure on bonds would be gone quickly anyway, but the equities can go all the way to crashing (multiple times).

I believe the only forced sell off of US Treasuries would come if foreigners decide to sell out of USD on a down grade. Most money markets, high quality bond holding funds should not have to sell and end US as we know it...

I always said that it is likely that the equities would suffer more than the US bonds and it seems like we are headed in that direction. Of course, the above scenario sounds way too far, but I do not think a down grade will be a good old correction, it should trigger a stock market crash... In a few days?!?

Edited by arbman, 26 July 2011 - 06:27 PM.

Looking at the April/may 1979 t-bill default. It was good for a .06 % on interest rates. The stock market pretty much in a trading range, the rest of the year. Sold off in the 1st Qtr of 1980. From about 880 in 79 to 720 in 1980 on SP. This Default is going to be a lot worse on equities I would anticipate. I think bonds will take a good hit as the interest rates rise to 4% on the ten year and 5% on the 30. Bernie

I thought US would not be down graded no matter what happens from here, but then I also think about the consequences of a down grade. Technically, it should mean very little for US Bonds honestly, an equity sell off would still make the bonds more attractive. But the faith of USD will likely continue to remain down though and this means the bonds would also be sold some more.

I'm still thinking the US stocks down, US$ up (treasury bonds up) relationship is still in effect.

I think gold will go nuts... USD went lower in 79-80, but of course if US stocks sell off enough, bonds and USD would eventually go up...

Edited by arbman, 26 July 2011 - 06:54 PM.

The rating agencies lost a lot of credibility over the subprime stuff and will probably not bend a bit as they attempt to goose their reputation.

Won't some mutual funds have to sell treasuries if they are downgraded? I think some high quality funds can only buy/hold bonds that have a triple-A rating. Rich

I would think most A3 accepting funds also accept A2 bonds, but they may further reduce exposure over time... I think the stocks are more vulnerable than the bonds, the bonds will appreciate tiny less in a stock sell off... Perhaps little happens to bonds because it has been known for months...

The Europeans are choosing to just ignore Moody's, etc. ratings agencies. The plan for Greece now involves default, but the ECB will redefine "Default" so they can continue to accept the Greek debt. Probably U.S. institutions will do the same. Sort of like how Clinton redefined "sex", only without the cigar.

mutual funds may have to change their mix of bonds, since many have percentages of what type they can hold - but I think they have a choice of which ratings agency rating to use. still, if bonds sell off because funds have to unload, it is in part a windfall to the big banks/dealers again, who will buy them at distressed prices and then be able to sell them right back to the same institutions. this makes me wonder about the origins of all these shenanigans, again. a while back, i said the banks would manipulate the PIIGs crisis so they could do a the same idea of the "convergence trade" (, as they did back in 98/99 right before the Euro was born) - this time, first its inverse as spreads widened, then the covergence trade when PIIGs were bailed - In 98/99 they bought greek, italian etc sovereigns paying higher interest(thus lower price), and shorted the german - the post EU convergence let them unload at a nice profit (e.g. greek bonds up, german flat to down). These plays are not too often, but if you can manufacture them with the help of politicians and rating agencies, you have a nice low risk profit. I believe this has been going on since the PIIGs erupted.