Monday, June 17, 2013

Outdated Ratings

Two Bloomberg reporters wrote a thought-provoking piece late last week (see Lost AAA Brings Falling Yields-to-Deficits on Downgrade) on the forthcoming ratings downgrade for the US.  In some ways they explore the age-old question of the (odd) relationship between a ratings change and the market price, or yield, of a bond.
"Yields on Treasuries are lower, the dollar is stronger and the S&P 500 Index (SPX) of stocks reached a record high since Aug. 5, 2011, when S&P said the U.S. was less creditworthy than Luxembourg and 17 other sovereigns."

But their article really tests the case of whether a US downgrade can be implemented despite an improving economic picture.
"... the unemployment rate has fallen, household wealth has reached a record and the budget deficit is shrinking. More downgrades may be coming, anyway."

Stepping back, it's fair to debate whether the economy is in better shape.  There are likely economists on both sides of the table on this one.  And certainly the statement that "the budget deficit is shrinking," if read on its own, can be misleading: the estimated budget deficit this year is expected to be lower than that of last year, but the overall federal deficit is expected to increase (or in more proper US fiscal parlance, the debt is expected to increase).

According to the Bloomberg article, "Moody’s Investors Service said it’s awaiting lawmakers’ budget decisions this year as it weighs reducing America’s Aaa."

But given the US GDP is growing, while Europe is in a recession, can it make any sense to downgrade the US?  Remember, the rating agencies claim their ratings are RELATIVE measures of risk.  In other words, the rating agencies are ranking each country relative to other countries.  So for the US to be downgraded, it would need to be getting worse relative to its competition.

Our guess is that what's happening here is the result of a fair share of awkwardness surrounding a situation in which many of the rating agencies' outstanding ratings may not reflect their current opinions.  If they delayed implementing the downgrade since the US first failed to meet the relevant criteria necessary to maintain the AAA rating, they would now look a little silly downgrading so long after the fact, now that the economy has stabilized, or turned the corner.

According to the article, "Fitch Ratings, which has a “negative” outlook on the U.S., said in February that the debt trajectory isn’t consistent with a AAA borrower."  Even if you agree with Fitch on this, okay, the US may still not be back at AAA if the rating agencies were to strictly adopt their criteria. But, as the Bloomberg article forces us to ask, how can a downgrade be appropriate now?

1 comment:

Anonymous said...

Prediction: Fitch and Moody’s will find some way to wiggle out of downgrading the US. If this prediction turns out to be true, it could provide evidence that sovereign ratings are commercially driven or it could simply reflect the fact that they buy your argument and don’t want to explicitly admit it.