The U.S. could lose its AAA credit rating? Why Treasury bond investors aren't flustered
For all the headlines that Standard & Poor’s generated Monday by warning that it might lower America’s AAA credit rating, the news has failed to panic the target audience: Treasury bond investors.
Yields on Treasury securities slipped on Monday from Friday’s levels, and on Tuesday the market ended mostly unchanged. The 10-year T-note yield (charted below), a benchmark for other long-term interest rates, eased to 3.37% from 3.38% on Monday.
If the threat of a downgrade from the gold-plated AAA rating had come as a real shock to investors, you would have expected bond prices to plunge and yields to spike. There was a small move up in yields early Monday morning but it didn’t last as buyers quickly came into the market.
After rising sharply last fall amid optimism about the economy, Treasury yields have mostly been stuck in a trading range since mid-December.
Why didn’t the S&P announcement cause a conniption in the Treasury market? Here are five possible reasons:
--- Nobody’s surprised. Is there a bond owner on the planet who doesn’t know that the U.S. has been running record budget deficits, which are at the heart of S&P’s concerns? “The action was a surprise, but the underlying fundamentals are not,” said Guy Lebas, fixed-income strategist at Janney Montgomery Scott in Philadelphia.
In general, he said, “The credit quality of sovereign [debt] is deteriorating” as governments have borne the cost of trying to pull their economies up from the vicious 2008-09 recession and financial system meltdown.
--- Nobody’s impressed. The leading credit-rating firms lost a massive amount of credibility amid the financial crisis, because it was their AAA ratings on what turned out to be garbage mortgage-backed bonds that helped precipitate the crisis.
So now, “Why listen to S&P on U.S. debt?” asks Barry Ritholtz, a well-known financial blogger and head of research firm FushionIQ in New York.
Another longtime critic of the ratings firms, Peter Schiff of Euro Pacific Capital, cites a separate credibility issue: He doubts that S&P would actually go through with a downgrade anyway.
“S&P simply does not have the integrity to honestly rate U.S. debt,” Schiff asserts. “It has too cozy a relationship with the U.S. government and Wall Street to threaten the status quo.” . . .
--- The Federal Reserve still is buying Treasuries. That’s a major continuing prop for the market and will be at least until the end of June, when the Fed is scheduled to complete the $600-billion purchase program it launched in November. Wall Street has estimated that the Fed is buying the equivalent of all new Treasury bond issuance.
We’ll hear more on the Fed’s plans for the program when policymakers meet April 27. Fed Chairman Ben S. Bernanke plans to hold his first-ever post-meeting press conference.
--- The worsening government-debt mess in Europe makes Treasuries look far safer by comparison. The U.S. is at risk of a rating downgrade, but in Europe the increasing risk is that some countries will have to renegotiate the terms of their outstanding bonds to lower their crushing debt burdens. That’s a nicer way of saying they’ll default.
Investors’ faith in the bonds of Europe’s weakest countries has eroded sharply in the last week, as shown by the market interest rates buyers are demanding on the debt.
The annualized yield on two-year Greek bonds (charted at right) soared to 20.72% on Tuesday, up from 16.42% a week earlier. Portuguese two-year-note yields are at 10.14% versus 9.05% a week ago. Irish two-year yields are at 9.69% versus 8.66%.
By contrast, two-year U.S. T-notes pay just 0.67%.
Of course, there are other ways to default on debt, and that’s the concern that some investors have with Treasuries.
Bill Gross, the Pimco funds bond guru in Newport Beach, made waves earliest this month with news that he was actively betting against Treasuries in his megafund, Pimco Total Return. Yields are too low to justify buying longer-term Treasuries, he said.
The U.S. government could effectively default “surreptitiously via accelerating and unexpectedly higher inflation . . . deceptively via a declining dollar -- currently taking place right in front of our noses . . . and stealthily via policy rates and Treasury yields far below historical levels -- paying savers less on their money and hoping they won’t complain,” Gross wrote in his April commentary on Pimco’s website.
For investors who want an excuse to avoid Treasuries, Gross probably carries more weight at this point than Standard & Poor's. But so far, even Gross hasn't been able to talk Treasury bond prices down and yields up.
-- Tom Petruno