JP Morgan's Comments on the SP Downgrade…. "fiscal issues are serious"

The budget/debt debate heats up in Washington as S&P lowers the outlook on US debt to negative from stable. There are a bunch of moving pieces related to spending in Washington that can be boiled down to 4 big issues: 1) the F11 budget, which was finally agreed to by Congress and signed into law late last week, stripped ~$40B from a pool of spending that will only cover the country through Oct; 2) the F12 budget; 3) the “long-term” budget (this is what was covered in the Paul Ryan document of a few weeks ago); 4) the debt ceiling (which the Treasury will start to bump against in mid May).

The primary reason S&P came out today had to do w/issue #3, the country's long-term plan for “fiscal sustainability”. However, S&P's core criticism wasn't financial or economic (i.e. they didn't express concern that the US lacked the capacity to deal w/its debt needs) but was rather a commentary on the country's political process (“We believe there is a material risk that U.S. policymakers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013”). While the budget has quickly become one of the most prominent issues in Washington (more than Iraq, health care, crude, etc) the worry is that both sides are so far apart that no credible/material action will be taken (one of the big fears is the large gap between Ryan and Obama when it comes to the budget and the fear that both sides are digging in their heals and preparing for the '12 elections instead of working to present a workable plan; indeed both sides today took S&P's release as justification for their respective view on the budget).

Comments from JPMorgan's T Belton on the S&P action

JP Morgan agree that the country's fiscal issues are serious, but they are also well known and we think priced into TSYs at this point.  The one new piece of information in today's S&P release was the threat that a d/g could occur within 2 yrs (sooner than expected).  Even if the timetable for a downgrade is moved slightly forward, today's announcement from S&P doesn't materially change our medium term outlook for Treasuries and we maintain our 3.60% target for 10-year rates and stay modestly bearish.  The last time a rating Agency revised downward its outlook on Treasuries was in January 1996.  Ten-year yields rose 9 bp the next day but the selloff was quickly reversed during the subsequent week (this is the Treasury's response to the S&P news http://1.usa.gov/fIBiff).