S&P Downgrading US

Yes, the rumor The Trader wrote about yesterday proved right. S&P is downgrading the US, despite many well  respected pundits saying that was impossible. Interesting times ahead to continue. Although S&P’s timing is not the best, both for market volatility and their popularity, some of the effects are priced in.

Expect more volatility, as risk has been mispriced for several years. As we have written during the spring, too many young quant academics have been pricing risk looking back at Garch etc models, and giving the past year’s low volatility environment way too much weight. It will take time to rinse out all these wrongly priced risk. For more reading on volatility, check Broken Volatility, not any more…

From Bloomberg,

Standard & Poor’s downgraded the U.S.’s AAA credit rating for the first time, slamming the nation’s political process and criticizing lawmakers for failing to cut spending enough to reduce record budget deficits.

S&P lowered the U.S. one level to AA+ while keeping the outlook at “negative” as it becomes less confident Congress will end Bush-era tax cuts or tackle entitlements. The rating may be cut to AA within two years if spending reductions are lower than agreed to, interest rates rise or “new fiscal pressures” result in higher general government debt, the New York-based firm said yesterday.

Lawmakers agreed on Aug. 2 to raise the nation’s $14.3 trillion debt ceiling and put in place a plan to enforce $2.4 trillion in spending reductions over the next 10 years, less than the $4 trillion S&P had said it preferred. Even with the specter of a downgrade, demand for Treasuries surged as investors saw few alternatives amid concern global growth is slowing and Europe’s sovereign debt crisis is spreading.

“The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics,” S&P said in a statement late yesterday after markets closed.

Full article, click here.

Expect war between the Fed and the S&P. First comments from Fed below. QE3 imminent? From Dow Jones,

Standard & Poor’s downgrade of the U.S. government’s debt will not affect the risk-based capital requirements for U.S. banks, federal regulators said Friday evening.

The Federal Reserve, Federal Deposit Insurance Corp. and other federal banking regulators said in a statement that the lowering of the U.S. government debt rating from AAA to AA+ “will not change” the risk weights for Treasury securities and other securities issued or guaranteed by the U.S. government or government agencies.

“The treatment of Treasury securities and other securities issued or guaranteed by the U.S. government, government agencies, and government-sponsored entities under other federal banking agency regulations, including, for example, the Federal Reserve Board’s Regulation W, will also be unaffected,” the regulators said.