Fears of another US credit downgrade are growing on Wall Street

Wall Street is growing nervous about the congressional supercommittee amid warnings from major banks that failure to reach a deal could lead to another downgrade of U.S. debt.

The bipartisan, 12-member panel has only until Nov. 23 to find at least $1.2 trillion in deficit cuts. Failure to strike a deal could rattle confidence in Washington and depress stock prices well into 2012, analysts say.

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Fitch Ratings, one of the three major credit raters, said in August that failure by the supercommittee to agree to a $1.2 trillion deficit-reduction package “would likely result in negative rating action.”

There have been no signs of progress from the secretive talks thus far. Sources close to the panel say members are deadlocked on basic questions about what policy issues to address and what budget scenarios to use.

 In its outlook for this week, Bank of America Merrill Lynch said it “expects” a downgrade by one of the three credit agencies “when the supercommittee crashes.”

Those analysts said the “not-so-super” committee is “very unlikely to come up with a credible deficit-reduction plan” because it is “hard to imagine” Democrats cutting entitlements or Republicans agreeing to tax increases. 

Supercommittee members are feeling the heat from Wall Street, aides said, and know the markets are watching their every move.

“The potential threat of another credit downgrade underscores the need for the committee to reach a bipartisan agreement that helps create jobs and reduces the deficit in a balanced way,” committee member Rep. Chris Van Hollen (D-Md.) said when asked via email about the pressure from Wall Street.

Banks are monitoring the supercommittee for fear of a Washington-driven market shock like the one that hit in August, when Standard & Poor’s downgraded U.S. bonds. That decision sent stocks spiraling and preceded a month of heavy losses for investors.

The Bank of America report predicts that the impact of another downgrade would be less than the 7 percent drop that came after S&P’s move in August, though the consequences for markets would linger into next year.

There have been signs of a market rebound in recent weeks despite the troubles in the economy and the European debt crisis. The S&P index reached positive territory for the year Monday, and the Dow Jones index inched closer to 12,000.

But the bull market could be short-lived if the supercommittee comes up empty-handed.

In its weekly analysis Friday, Deutsche Bank said the supercommittee report is “perhaps” the most important issue facing the markets.

“The fiscal calendar is likely to be a source of considerable volatility,” the report warned.

If the deficit panel fails to meet its goals, automatic cuts to defense and nondefense spending will begin in 2013. But Wall Street fears Congress will be tempted to remove the “triggers” if the supercommittee fails, wiping out the second round of deficit reduction in the debt-ceiling deal and putting the nation at risk of another downgrade.

Moody’s Investors Service analyst Stephen Hess confirmed to The Hill on Monday that a failure of the supercommittee would be a factor in re-evaluating the U.S. credit rating. He said Moody’s is “agnostic” on whether spending cuts, taxes or the trigger are the best path to deficit reduction.

“For us, the composition is less important than the actual magnitude [of the cuts],” Hess said.

In the aftermath of the standoff over the debt ceiling, S&P lowered the U.S. credit rating from AAA to AA+ with a negative outlook — leaving open the possibility of a further downgrade. 

S&P made clear that the inability of Congress to deal with the nation’s fiscal problems prompted the rating dip. The decision was met in Washington with another round of finger pointing from Democrats and Republicans over which side was to blame.

Despite the partisan atmosphere, Goldman Sachs expressed optimism that the supercommittee is on track for a deal, saying in its weekly outlook that an “agreement of some type is the most likely scenario.”

Goldman nonetheless cautioned there remains “the potential for a downside surprise.”

“While also possible, it is much harder to see an agreement reaching or exceeding the $1.2 trillion target,” Goldman political analyst Alec Phillips wrote. “Further sovereign downgrades remain a significant risk.”

Morgan Stanley wants to see Washington agree on stimulus measures to pump up the economy and said the market is looking at the supercommittee for signs that Washington can get things done.

But it said in its outlook for the week that the supercommittee appears to be in “gridlock” and that “failure of the supercommittee would also make it more difficult to find a path forward for consideration of fiscal stimulus next year.”

Michael Cembalest, chief investment officer for JP Morgan Chase, wrote that failure by the group could even herald the end of the dollar as a reserve currency.



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