This is not a good sign for the economic recovery that everyone was hoping for.
http://online.wsj.com/article/BT-CO-20110805-718118.html
NEW YORK (Dow Jones)–Standard & Poor’s took the unprecedented step of downgrading the U.S. government’s “AAA” sovereign credit rating Friday in a move that could send shock waves through global financial markets and potentially undermine world economic growth.
In a press release, S&P, cut its top-notch long-term credit rating for the U.S. Treasury’s debt to AA+ with a negative outlook. It is the first time in modern history that one of the three main ratings firms has stripped the U.S. of its coveted AAA rating.
S&P warned last month that if the U.S. government didn’t approve a credible medium-term plan to shrink its fiscal shortfall, it would downgrade the rating even if Congress approved a debt deal that raised the Treasury’s borrowing limit. On Tuesday, just in time for a deadline to avoid default, U.S. lawmakers passed a bill increasing the U.S. debt ceiling by $2.1 trillion. However, the amount of planned quid-pro-quo deficit cuts ran to $2.4 trillion, well short of the $4 trillion that S&P had suggested was needed to put the nation’s fiscal house in order.
Some market participants have warned that the tepid pace of economic recovery means that even deeper fiscal cuts may be needed to reduce the share of public debt to U.S. gross domestic product, a closely watched gauge of a nation’s fiscal health.
The two other main ratings companies, Fitch Ratings and Moody’s Investors Service, both affirmed their top-notch ratings of the U.S. during the week, although Moody’s assigned a negative outlook to its “Aaa” rating. Given that it made the most aggressive warning before the debt deal, S&P’s announcement then became a closely anticipated event.
While many have expected it, the downgrade by S&P could generate anxiety in the global financial markets, which were roiled this week by heightened fears about the global economy and the euro zone’s debt problems.
The news could spark selling in U.S. stocks and the dollar on Monday but, paradoxically, the Treasury market could see two-way flows. Some investors may be forced to sell Treasurys as they are required to hold only AAA-rated assets, but the selloff in risky assets might also push buyers back to U.S. government bonds, which function as a global safe haven in times of market turmoil. Few markets match the depth and liquidity of the Treasury market, which has $9.3 trillion in debt outstanding.
For investors, a key concern would be the ripple effect on global markets. Treasury yields have long been used as the benchmark for a variety of interest rates from consumer loans to corporate finances. So if the downgrade raises the U.S. government’s borrowing costs, the same could happen to other markets as investors dump riskier assets.
In addition, Treasury securities are widely used as collateral for banks, dealers and hedge funds to borrow short-term loans in the repurchase-agreement markets, or repos.
One concern is that Treasury bonds might no longer be considered top-quality collateral in repos, thereby choking a primary channel of short-term funding for banks. That in turn could push investors such as U.S. money funds to cut lending to banks, stifling liquidity and pushing up the cost of funding.
Repos, which grew to become the so-called “shadow banking system,” are often described as the oil that lubricates the economy. Higher borrowing costs would thus have a broad impact, hurting everything from consumer borrowing to corporate finance.
There are about $3.94 trillion in Treasurys used as collateral for repos, according to data from J.P. Morgan. Another report from Bank of America Merrill Lynch says that roughly 74% of primary dealer repo financing–about $2.1 trillion–involves Treasury collateral.
-By Min Zeng, Dow Jones Newswires; 212-416-2229; [email protected]