As debt ceiling negotiations continue to make little headway this week, a slash of the USA AAA sovereign debt rating by credit rating agencies Moody’s (NYSE:MCO), Standard and Poor’s (NYSE:MHP), Fitch and others seems increasingly likely. Aside from the effects a cut to AA or lower would likely have on interest rates, is there any real cause for concern behind a lower credit rating?
Yahoo Finance reports that current action in the U.S. treasury market may signal politicians are overplaying the need to worry about such an outcome. “The closely watched 10-year Treasury has gained since the beginning of the year, dropping its yield from 3.4% to 3.0%. That means interest rates on the things the president mentioned aren’t expected to “skyrocket” soon—not even if the rocket he had in mind is only one of those backyard balsa-wood-and-gunpowder fliers.”
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One explanation is that markets have already priced in the potential impact of a downgrade. The initial warnings from Moody’s (NYSE:MCO) and Standard and Poor’s (NYSE:MHP) came months ago, so investors have had plenty of time to adjust to the threat of likelihood of a lower US credit rating. Another is that people are simply ignoring the advice of agencies, citing their historic lapses of judgment that saw the same esteemed groups issue investment grade ratings on Enron four days before it filed for bankruptcy, and gave similar credit-worthy marks to mortgage-backed securities that proved exchangeable for little more than toilet paper after the financial crisis in 2008. One more line of thought is that ratings agencies aren’t really even qualified to be making judgments on US treasury bonds (NYSE:TLT). The size and scale of the treasury market, coupled with the nature of the largest treasury investors (foreign governments, hedge funds, US institutions), make it very difficult for a small group of private agents to gauge fair market value, or likelihood of failure to repay bonds. “The sort of investors who decide Treasury prices—foreign governments, giant mutual funds, the Social Security Trust Fund—don’t wait for S&P or Moody’s to tell them whether to buy. They do the math themselves,” adds Smart Money’s Jack Hough.
When the dust finally settles, whether or not a debt (NYSE:TLT) ceiling deal is reached, the current “crisis” may prove to be more elucidating of a broken political system than a threat to the global economy. Markets will go on unabated after maybe a short hiccup, but the American people’s faith in its political leadership will remain tarnished for far longer.