Pleasingly, recent events offer us the opportunity to pay tribute to Donavan Leitch, Sr. (aka Donavan) – a Scottish folksinger, who, in the mid-60’s, was widely (if implausibly) hailed as the British Bob Dylan. No, he never remotely approached those heights, but he did have a couple of moments. As in Mellow Yellow. Or Sunshine Superman.
Or Season of the Witch – one of several compositions better presented by cover versions. In this case, Super Sessions, an ensemble that included Al Kooper, Mike Bloomfield, and Stephen Stills.
That version of our title song rocked. But what really put it on the map for me was Bowie’s variation on the titular theme, in perhaps his finest (if lesser known) composition — Diamond Dogs. Check it out. And pay particular close attention when he belts out the line about “the year of the scavenger, season of the bitch”.
But right now, as is evident, it is neither the season of the witch, nor that of the bitch.
It is, rather, the season of the Fitch. As in the Fitch Ratings Agency, which, as everyone knows, rather unceremoniously this past week, and without warning of any kind, downgraded the debt obligations of the United States of America.
Weren’t these guys supposed to put us on watch or something first?
Well, anyway, they didn’t. Went right ahead and rudely downgraded our asses. From AAA to AA+.
It was a somewhat mind-blowing gesture, and yes it took everyone by surprise. Investors, though they responded with dignity, were far from amused. But more about that later, as a couple of thoughts supersede here.
The first is the wearying but inevitable parallels to similar episodes, most notably the identical stunt being pulled by larger rival Moody’s in 2011. That move, was highly telegraphed – albeit to a select audience – leading to one of the most astonishing insider trades in market history.
Specifically, then-CEO Vincent Forlenza, evidently unclear on certain key concepts, called the CEOs of several Bulge Bracket firms to ask them, you know, hypothetically, the following question. If the ratings agency was going to downgrade U.S. debt (at the time an unprecedented action), when do they think would be the best day/time to do so?
It was all, as said, hypothetical, but each Wall Street Chieftain suggested after the close of business the following day (August 4th), which, being a Friday, would give investors all weekend to ponder the implications, without the distraction of being able to adjust their portfolios to the new reality. They then immediately instructed their trading desks to sell short everything in sight.
Well, wouldn’t you know it? The hypothetical then became the actual.
I kind of smelled a rat at the time, because the equity markets were in free fall all that session (which, ironically, was also President Obama’s 50th birthday), without an apparent catalyst. I knew that the big trading desks were sellers all day long, and the pressure unrelenting, tripping circuit breakers and other niceties. But I didn’t know why they were selling.
Then, the announcement came, and it all began to make sense. It was a helluva day – one for the ages — on the Goldman, Morgan(s), and Citi trading desks, and, when the dust settled, the Gallant 500 had yielded > 7% of hard-retaken ground in the wake of the 2008 Crash; Colonel Naz almost 20%.
The Bond Complex on the other hand, took the announcements in stride, sustaining a bid across that entire summer. Of course, that market was in what turned out to be the early stages of that historic money printing/bond-buying spree otherwise known as Quantitative Easing. Though at the time, the Fed Balance sheet stood at a quaint $2.5T, this figure was in fact 150% more than the central bank had held for eons prior to the crash:
Fed’s Witchin’, Bitchin’, Fitchin Balance Sheet
Of course, said asset values held by the Fed tripled and then-some in the intervening years, as aided, in part, by the November ’11 QE2 launch, which committed Big Ben and his crew to the monthy purchase of $75B of Treasury Securities.
Risk assets soon blessedly recovered, retaking lost ground within 2 short months, and, in the time since, the Gallant 500 is about 4.5x the Moody lows; Col. Naz is more than a 7 bagger.
At the time of the ’11 downgrade, Unemployment stood at 9% vs. ~3.5% today. CPIs were where they are at present, at just over 3%. Then, as now, the country was forced to endure a high-drama but ultimately pro-forma Debt Ceiling showdown. Twelve years ago, the Fed was accumulating assets and printing money, a practice they would accelerate over the ensuing decade. Now, of course, the reverse policy applies.
In 2011, the Washingtonian defecit was ~$15T and has more than doubled since. Annual interest payments were then just over $400B, and are now about to surpass $1T:
Oh yeah, and the Treasury just announced a quarterly refunding cycle, which, for the first time in history, will exceed $1T. It kicks off this week, with the sale of> $100B across the Curve.
So, the $33T Questions (named in honor of the value of our current obligations) are: a) was Fitch more justified last week than Moodys was in ’11; b) why did they pull this stunt; and c) why now?
Let’s first offer the caveat that that at all this is nonsense. U.S. paper is no more of a default risk than it has been since aftermath of the Revolutionary War. Two abiding wild cards ensure this – the monetary printing press and the American Military. And, as to any comparison of the timing of these two assaults on our financial sensibilities, I think the argument could go either way. Undoubtedly, our fiscal position has weakened, rendering debt service more problematic than in ’11. On the other hand, in ’23, Debt Ceiling showdowns and 13 figure revenue shortfalls are matters of the routine.
So, why now? This, in my judgment, is the most interesting and elusive of the issues. Some of this is plainly political, but unpacking that aspect of the puzzle is a task above my paygrade.
I’m more thinking that Fitch, being aware that any bona fide (as opposed to technical) failure of the U.S. Treasury Complex is lights out for the entire global capital economy, is putting the world on notice that ALL forms of debt are subject to a heightened default exposure. Rather than downgrading all credit instruments, they issued this message by whacking at our Bills, Notes and Bonds.
If I’m right, I say good on them. Global credit debt are teetering from any longterm viewpoint. The reckoning will come, even if the timing is uncertain, and, in all likelihood, deferred.
But unlike 2011, investors have absorbed the Fitch Bomb with remarkable equanimity. Yes, stocks and bonds sold off, but both were, by the end of the week, offering indications of recovery.
Only time will tell if Fitch’s forboding action will prove to have been prescient, and whether its bigger rivals – not only Moodys, but S&P, will follow suit. All acted in sequence back in the day, but later, with timing I am unable to pinpoint, Moodys quielty restored the Aaa rating on our paper.
For now, the smallest of the 3 firms who dominate the evaluation of credit worthiness stands alone.
Must be the Season of the Fitch.
TIMSHEL