The Global Radar Screen 7/22/2011

Posted July 22, 2011 by CLeahey

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Overview—Europe 1, US 0

Updates on the soverign debt situations are mixed.  In the Europe, real progress has been made. Policymakers finally reached the ultimate destination of a Greek default, establishing a Brady-like solution in which bondholder voluntarily accept perhaps a 20% haircut on their existing Greek soverign holdings in exchange for new longer-maturity bond earnings 3.5% but with an implicit EU guarantee.  This represents €37B in savings of an overall €159B second package for Greece.  In addition, the EFSF has been overhauled, with the ability to assist any European nation, not just those already in trouble, with precautionary lines of credit and the ability to recapitalize European banks.  So Europe moves closer to a true monetary fund.  But the deeper question of promoting European-wide growth was not addressed, as these struggling peripheral nations desperately need stronger regional growth if they are to pay off their reduced indebtedness.  In the US, investors were encouraged by the renewed moves to a grand compromise, either by the Gang of Six plan or another attempt by Obama and Boehner.  Unfortunately, we still think the House Republicans will reject a grand compromise since it will include tax increases.  Even though the House is walking way from the budget deal of the century, their refusal means that either a smaller deal of under $1.5 trillion in outlay cuts or a face saving option of no budget deal at all which be included with a debt ceiling extension.  Success at passing a debt ceiling even with no budgetary “teeth” may avoid a 10% meltdown in the equity market, similar to what happened after the “must pass” TARP legislation initially failed to pass Congress.  But this success will mean failure at convincing the rating agencies to downgrade US debt.  Whatever limited deal that does pass House Republican muster will not be “credible” enough ($4 trillion in size with bipartisan support (tax increases)) to avoid a downgrade within 90 days.

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