From The Wall Street Journal:
The move by Standard & Poor's to cut the U.S. credit rating to double-A-plus added more uncertainty to global markets already buffeted by concerns over debt crises and slowing economic growth. Here are answers to some of the most important questions facing investors.
Q: What's the difference between triple-A and double-A-plus? That doesn't sound so bad.
A: It isn't so bad—and there isn't much difference between the two. Technically, double-A-plus is considered "high-grade" credit, while triple-A is "prime." The likelihood of getting paid back by a double-A-plus credit is considered "very strong," while a triple-A credit's likelihood of paying you back is "extremely strong."
The U.S. is a special case, given its status as the world's largest economy and printer of the world's reserve currency. If your personal credit score fell, you would almost certainly have to pay more to borrow. But because so many investors want to hold Treasurys and the dollar, the U.S. can get away with a slight credit-rating downgrade without having to pay more to borrow.
Many other large, developed economies, including Japan, Canada and Australia, have lost triple-A ratings in the past and ended up not paying more to borrow in the long run. Japan lost its triple-A rating in 2001, yet the yield on its 10-year note, which moves in the opposite direction of price, is about 1% today.
Keep in mind that Fitch Ratings and Moody's Investors Service have left their triple-A ratings on the U.S. intact and don't expect to change them anytime soon. On July 27, Fitch went so far as to say a downgrade by one ratings firm would do little to change the fact that market participants would consider Treasurys a "high-quality credit" for the "foreseeable future."
Q: Luxembourg is rated triple-A. Is the U.S. really a bigger risk?
A: No. Luxembourg is a perfectly sound credit risk, but it lacks many of the advantages of the U.S. For example, because it is part of the euro zone, it doesn't have a large printing press to back its debt.
Sure, the world's other remaining triple-As, including Germany, Canada and Australia, are in better financial shape than the U.S. But moving your cash into foreign debt also means owning foreign currencies. In Germany's case, that means owning euros, not exactly a safe haven now.
Q: So the principal and interest payments on Treasurys are safe. But will the downgrade cause their value to drop?
A: In the short term, probably not. Don't forget that, right now, investors are most concerned about a weakening U.S. economy, an environment that should support Treasury prices until recession fears ease.
Meanwhile, the so-called bond vigilantes, who are supposed to enforce fiscal discipline on profligate governments by dumping their bonds and jacking up their borrowing costs, have been notably absent since the financial crisis began.
For better or worse, Treasurys are the largest fixed-income asset class in the world, by far, and the likelihood of default is next to zero. The dollar is, for now at least, the world's reserve currency, meaning non-U.S. central banks will have to keep buying Treasurys. There is really no alternative available.
Q: But won't some investors be forced to sell?
A: Maybe a few: some pension funds, university endowments and other big investors are required to hold triple-A securities. But managers are considering tweaking their rules to allow them to keep Treasurys, given their liquidity and relative safety.
U.S. banking regulators have confirmed that the downgrade will not force banks, which have big Treasury holdings, to raise any more capital as a cushion against losses. And remember—the U.S. is still considered triple-A by Moody's and Fitch. That split rating should provide a further buffer from forced selling.
Q: What about money-market funds?
A: Short-term Treasury ratings weren't affected, so money-market funds won't be forced to sell. Keep in mind also that most Treasury money funds are required to buy U.S. Treasurys—not triple-A securities. And most of the money funds that do have triple-A requirements have taken steps or are prepared to take steps to change their investment criteria to allow for Treasurys.
Q: What is the likely effect on interest rates?
A: The market has been bracing for this downgrade for a while, s, particularly on Friday, when rumors of it were widespreado it is possible that most of the increase in yields has already taken place.
In any event, the history of Japan and others suggests that a downgrade could have no long-term effect on borrowing costs. Investors will likely respond more to inflation or deflation pressures, central banks and economic growth than to what one ratings firm says.A: History isn't much of a guide. Some nations' stock markets have quickly shrugged off downgrades in the past, while others haven't, notes Jason Goepfert at Sundial Capital Research. Coming after the worst week for stocks since 2008, the timing for the downgrade couldn't have been much worse. That said, there has been some warning that this was coming. And if investors determine the long-term effects will be manageable, any short-term market losses could be made up quickly.
Q: Will this affect corporate bonds?
A: Several triple-A-rated insurance companies and some other financial firms with ties to the government are at risk of a downgrade, S&P has said. But most other corporate borrowers will be unaffected. Only four U.S. nonfinancial companies have triple-A ratings: Automatic Data Processing Inc., Exxon Mobil Corp., Johnson & Johnson and Microsoft Corp. S&P has said they won't be downgraded as a result of the U.S. move.
Like the government, companies—including those with ratings lower than triple-A—have been borrowing at the lowest levels in decades. That's unlikely to change as a result of the downgrade. If anything, they could benefit as investors look for higher-yielding alternatives.
Q: Is the mortgage market at risk?
A: S&P has warned it could downgrade government-backed mortgage agencies Fannie Mae and Freddie Mac, which were effectively nationalized during the financial crisis.
In theory, the downgrade should raise rates on mortgages across the country—but mortgage bonds have been in even hotter demand from investors than Treasurys lately, given their higher interest rates and government backing.
Kevin Cavin, mortgage strategist at Sterne Agee in Chicago, says the mortgage market might already have priced in the downgrade. While the unsecured debt of Fannie and Freddie might suffer, Mr. Cavin suggests, mortgage bonds, which have homes backing them as collateral, could stay in high demand.
For homeowners, the effects of the downgrade are likely to be minimal. Mortgage rates have plunged once again near record lows, but the drop hasn't sparked much of a boom in refinancing or new-home purchases. So any small increase in mortgage rates will likely have little effect on the housing market.
The move by Standard & Poor's to cut the U.S. credit rating to double-A-plus added more uncertainty to global markets already buffeted by concerns over debt crises and slowing economic growth. Here are answers to some of the most important questions facing investors.
Q: What's the difference between triple-A and double-A-plus? That doesn't sound so bad.
A: It isn't so bad—and there isn't much difference between the two. Technically, double-A-plus is considered "high-grade" credit, while triple-A is "prime." The likelihood of getting paid back by a double-A-plus credit is considered "very strong," while a triple-A credit's likelihood of paying you back is "extremely strong."
The U.S. is a special case, given its status as the world's largest economy and printer of the world's reserve currency. If your personal credit score fell, you would almost certainly have to pay more to borrow. But because so many investors want to hold Treasurys and the dollar, the U.S. can get away with a slight credit-rating downgrade without having to pay more to borrow.
Many other large, developed economies, including Japan, Canada and Australia, have lost triple-A ratings in the past and ended up not paying more to borrow in the long run. Japan lost its triple-A rating in 2001, yet the yield on its 10-year note, which moves in the opposite direction of price, is about 1% today.
Keep in mind that Fitch Ratings and Moody's Investors Service have left their triple-A ratings on the U.S. intact and don't expect to change them anytime soon. On July 27, Fitch went so far as to say a downgrade by one ratings firm would do little to change the fact that market participants would consider Treasurys a "high-quality credit" for the "foreseeable future."
Q: Luxembourg is rated triple-A. Is the U.S. really a bigger risk?
A: No. Luxembourg is a perfectly sound credit risk, but it lacks many of the advantages of the U.S. For example, because it is part of the euro zone, it doesn't have a large printing press to back its debt.
Sure, the world's other remaining triple-As, including Germany, Canada and Australia, are in better financial shape than the U.S. But moving your cash into foreign debt also means owning foreign currencies. In Germany's case, that means owning euros, not exactly a safe haven now.
Q: So the principal and interest payments on Treasurys are safe. But will the downgrade cause their value to drop?
A: In the short term, probably not. Don't forget that, right now, investors are most concerned about a weakening U.S. economy, an environment that should support Treasury prices until recession fears ease.
Meanwhile, the so-called bond vigilantes, who are supposed to enforce fiscal discipline on profligate governments by dumping their bonds and jacking up their borrowing costs, have been notably absent since the financial crisis began.
For better or worse, Treasurys are the largest fixed-income asset class in the world, by far, and the likelihood of default is next to zero. The dollar is, for now at least, the world's reserve currency, meaning non-U.S. central banks will have to keep buying Treasurys. There is really no alternative available.
Q: But won't some investors be forced to sell?
A: Maybe a few: some pension funds, university endowments and other big investors are required to hold triple-A securities. But managers are considering tweaking their rules to allow them to keep Treasurys, given their liquidity and relative safety.
U.S. banking regulators have confirmed that the downgrade will not force banks, which have big Treasury holdings, to raise any more capital as a cushion against losses. And remember—the U.S. is still considered triple-A by Moody's and Fitch. That split rating should provide a further buffer from forced selling.
Q: What about money-market funds?
A: Short-term Treasury ratings weren't affected, so money-market funds won't be forced to sell. Keep in mind also that most Treasury money funds are required to buy U.S. Treasurys—not triple-A securities. And most of the money funds that do have triple-A requirements have taken steps or are prepared to take steps to change their investment criteria to allow for Treasurys.
Q: What is the likely effect on interest rates?
A: The market has been bracing for this downgrade for a while, s, particularly on Friday, when rumors of it were widespreado it is possible that most of the increase in yields has already taken place.
In any event, the history of Japan and others suggests that a downgrade could have no long-term effect on borrowing costs. Investors will likely respond more to inflation or deflation pressures, central banks and economic growth than to what one ratings firm says.A: History isn't much of a guide. Some nations' stock markets have quickly shrugged off downgrades in the past, while others haven't, notes Jason Goepfert at Sundial Capital Research. Coming after the worst week for stocks since 2008, the timing for the downgrade couldn't have been much worse. That said, there has been some warning that this was coming. And if investors determine the long-term effects will be manageable, any short-term market losses could be made up quickly.
Q: Will this affect corporate bonds?
A: Several triple-A-rated insurance companies and some other financial firms with ties to the government are at risk of a downgrade, S&P has said. But most other corporate borrowers will be unaffected. Only four U.S. nonfinancial companies have triple-A ratings: Automatic Data Processing Inc., Exxon Mobil Corp., Johnson & Johnson and Microsoft Corp. S&P has said they won't be downgraded as a result of the U.S. move.
Like the government, companies—including those with ratings lower than triple-A—have been borrowing at the lowest levels in decades. That's unlikely to change as a result of the downgrade. If anything, they could benefit as investors look for higher-yielding alternatives.
Q: Is the mortgage market at risk?
A: S&P has warned it could downgrade government-backed mortgage agencies Fannie Mae and Freddie Mac, which were effectively nationalized during the financial crisis.
In theory, the downgrade should raise rates on mortgages across the country—but mortgage bonds have been in even hotter demand from investors than Treasurys lately, given their higher interest rates and government backing.
Kevin Cavin, mortgage strategist at Sterne Agee in Chicago, says the mortgage market might already have priced in the downgrade. While the unsecured debt of Fannie and Freddie might suffer, Mr. Cavin suggests, mortgage bonds, which have homes backing them as collateral, could stay in high demand.
For homeowners, the effects of the downgrade are likely to be minimal. Mortgage rates have plunged once again near record lows, but the drop hasn't sparked much of a boom in refinancing or new-home purchases. So any small increase in mortgage rates will likely have little effect on the housing market.
posted by Sid Cottingham | 5:34 AM
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