Analysis: Belt-tightening may squeeze economy, markets (Reuters)

NEW YORK (Reuters) – Two years removed from its worst recession since World War Two, the U.S. economy is still struggling to create jobs, and things could get even tougher if all the talk of belt-tightening in Washington becomes reality.

Data on Friday showed hiring ground to a near halt last month, driving the jobless rate up to 9.2 percent and casting doubt on whether a sluggish U.S. recovery would soon pick up steam.

This all but ensures the Federal Reserve will keep interest rates at record lows well into 2012. But help probably won't be as forthcoming from Congress and the White House, which are locked in battle over cutting a $1.4 trillion budget deficit.

The problem is one of timing: Economists and investors fear that with weak labor and housing markets causing consumers to tighten their own belts, the last thing the economy needs is an aggressive dose of austerity from the federal government.

"The U.S. government has its work cut out for it," said Douglas Borthwick, managing director at Faros Trading in Stamford, Connecticut. "U.S. fiscal problems have been put off for so long that the government has to cut spending at a time when the economy is unable to absorb it."

As a share of output, the $1.4 trillion budget gap expected for the fiscal year ending in September is one of the largest since World War Two.

President Barack Obama and Republican leaders are aiming for savings of $2 trillion to $4 trillion over 10 years but are at odds over the right mix of spending cuts and tax hikes.

A deal is needed by August 2 in order to lift the $14.3 trillion cap on government borrowing.

While that's not an astronomical amount for a $14 trillion economy, it still amounts to tighter policy at a time that many economists say requires even more aggressive federal spending.

Much depends on the size, scope and timing of spending cuts. If they are large enough and take effect next year, they will depress corporate earnings and weigh on equity markets, according to Credit Suisse U.S. equity strategist Doug Cliggott.

Solid corporate earnings and loose monetary and fiscal policies have helped the S&P 500 index double in value since early 2009.

"We really are in a bind here," Cliggott said, "We have to start addressing the deficit, and if it means a rough stretch for corporate profits and the equity market, then they go through a rough stretch. Putting it off is not the answer."

WALKING THE TIGHTROPE

Fed Chairman Ben Bernanke and others have urged lawmakers to reduce the deficit but to back-load the most draconian spending cuts or tax hikes to shield the fragile economy.

"The idea seems to be that reducing the deficit will somehow produce jobs," said Kathy Jones, fixed income strategist at Charles Schwab. "I'm not sure there's a direct correlation there. We need to allow growth now, because stronger growth will help the long-term fiscal outlook."

That's clear in Europe. Facing default, Greece's parliament last week adopted a package of large and unpopular spending cuts and tax hikes in exchange for international aid.

But economists and investors fear the austerity will make it difficult for the country to grow its way back to health.

Britain, too, has been more aggressive than the United States in cutting spending and raising taxes, and the pace of growth slowed to 1.6 percent in the 12 months to March. Markets are even starting to bet the central bank may have to act by pumping more money into the economy.

David Semmens, U.S. economist at Standard Chartered, said the 2012 election may clip even the biggest deficit hawks' wings, as lawmakers won't want to lose votes. A rising jobless rate is an impediment for Obama's reelection chances.

"I think any spending cuts will be aimed at 2013," he said.

But history does suggest a commitment to fiscal probity is required for long-term economic health. Cliggott said countries with debt-to-output ratios above 90 percent have traditionally grown at slower rates than those with stronger finances.

"It shows the tightrope that has to be walked," said Greg McBride, senior financial analyst at Bankrate.com. "We've got to rein in the government red ink so we don't in coming years face a day of reckoning. But it's a balancing act, because if you rein it in too much, it will plunge us into recession."

(Editing by Leslie Adler)

Analysis: Portugal poisoned by Greece in cut to junk status (Reuters)

LISBON (Reuters) – A downgrade of Portugal's credit rating to junk status underlines how the Greek crisis is poisoning other weak countries in the euro zone, regardless of their own efforts to shrink their debt and return to growth.

Moody's Investors Service on Tuesday became the first rating agency to cut Portugal below investment grade, causing the 10-year Portuguese government bond yield to leap more than 1 percentage point to euro-era highs.

The agency cited worries that administrative problems and slow economic growth might prevent the Portuguese government from hitting ambitious targets to shrink its budget deficit over the next three years under a 78 billion euro international bailout.

But Moody's also said efforts by the European Union to have private investors bear part of the burden of supporting Greece, through a "voluntary" rollover of maturing Greek debt, threatened investor confidence in Portugal as well.

If investors believe the EU may follow the Greek model and pressure them into bearing part of the cost of future aid to Portugal, they may become less willing to lend to Lisbon, reducing the chance that it can resume borrowing from markets in 2013 as planned, Moody's said.

The malign example of Greece, rather than anything which has happened inside Portugal in the last few months, appears to be the main reason for the decision by Moody's to slash Lisbon's rating by four notches, other analysts said.

"I think the main problem internally is growth and on that side not much has changed," said Diego Iscaro, an economist at IHS Global Insight. "So four notches is possibly more to do with Europe-wide developments.

"The concern of Moody's is that we may see a repetition of Greece with Portugal next year. It is a different situation, but what Moody's is saying is that the resolution with the private sector may be the same."

SWITCH WITH IRELAND

The Moody's downgrade means many investors will now view Portugal as the euro zone's biggest danger spot after Greece. Until recently, that position was held by Ireland, which is still rated as investment grade by all three major agencies; perceptions began to change when the Portuguese 10-year bond yield rose above the Irish yield in mid-June.

Moody's said there was a growing risk that Portugal would need a second international bailout, beyond the 78 billion euros of emergency loans which are due to flow into 2013. The size of any additional bailout would depend on how long the EU needed to keep Portugal afloat.

Under current plans, Lisbon is expected to raise 10 billion euros in long-term bonds in 2013 and 6 billion euros in the following year, Iscaro said. So financing Portugal through the end of 2014 might require an extra 16 billion euros of loans -- depending on many factors including Lisbon's success in cutting its budget deficit and selling state assets.

Iscaro said it was only likely to become obvious around the third quarter of next year whether Portugal would need a new bailout.

But Citibank, in a report on Wednesday, said a second bailout was probable.

"Portugal is likely to require a second package at some point in 2012, when the International Monetary Fund is likely to request additional measures to close the funding gap for the 12 months ahead -- as was the case in Greece," it said.

Many Portugal-based economists disagreed with the Moody's downgrade, arguing that the agency had not paid enough attention to the determination of Lisbon's new center-right government in meeting fiscal goals set by the EU and the IMF.

The government, which took office last month, has already announced an extraordinary tax on year-end bonuses and promised to speed up spending cuts beyond the terms of the bailout deal, which was agreed before a June 5 general election.

"We think this cut by Moody's was absurd and out of time. It did not even consider the new government's measures and it did not wait for the first evaluation of the implementation of the austerity plan," said Filipe Silva, head of debt at Banco Carregosa, a Portuguese private bank.

But as long as the Greek crisis suggests to investors that they may be forced to restructure their holdings of debt in weak euro zone countries, Portugal's success with domestic fiscal reforms may fail to impress the rating agencies or markets.

Richard McGuire, interest rate strategist at Rabobank, said the Moody's downgrade had underlined that "in terms of 'restructuring dominoes', Portugal is the next man standing."

"The prospect, or even simple speculation, of a series of defaults will increase the risk of contagion spreading," McGuire said.

(Editing by Andrew Torchia)