Analysts, strategists and economists from around the country (and around the world) were compelled to weigh in Wednesday on Fitch’s decision to join S&P (a dozen years later) in downgrading the US credit rating.
The move, which TD Securities’ Gennadiy Goldberg amusingly described as “a tree falls in the forest,” was mostly symbolic. Interested parties were divided on what, exactly, it symbolized. To Larry Summers, it symbolized ineptitude on Fitch’s part. To other observers, it was a cautionary tale on the extent to which D.C. gridlock and partisan rancor are imperiling America’s creditworthiness. For most, it was just another in a long list of warnings about an allegedly “unsustainable” fiscal trajectory.
In the market’s view, Fitch’s decision is mostly irrelevant. That’s not to suggest equities won’t trade it, or that, when combined with upsized borrowing and ongoing macro uncertainty, there isn’t a read-through for US yields. It’s just to say there are no Treasury “alternatives,” and since 2011, investors have taken steps to ensure that ratings actions can’t force them to sell. This discussion is in many (most) respects, a waste of time.
But, as noted above, there’s no not having it — the discussion, I mean. Fitch took the plunge, so now everybody has to talk about it. This is the third article published in these pages over 10 hours, for example, and there will be invariably be more.
Below, find a selection of color from analysts and strategists. Again, this is obligatory, and I’d be remiss not to go through the motions.
We do not believe there are any meaningful holders of Treasury securities who will be forced to sell due to a downgrade. S&P downgraded the sovereign rating in 2011 and while it had a meaningfully negative impact on sentiment, there was no apparent forced selling at that time. Because Treasury securities are such an important asset class, most investment mandates and regulatory regimes refer to them specifically, rather than AAA-rated government debt. — Alec Phillips, Goldman
The market response implies that [Wednesday’s] refunding announcement [was] far more relevant to the near-term direction of US rates and that certainly resonates from our perspective. There was more concern regarding the money market and investors’ ability to continue buying Treasurys when the US first lost its AAA distinction in 2011. At this stage it’s old hat, as it were. Investment mandates have long since been adjusted from ‘AAA’ requirements to a version of ‘US Government quality or the equivalent’ in a move that has largely defanged this and any future downgrade. Moreover, the decision is an acknowledgment of the market’s angst (and annoyance) with the entire debt-ceiling dynamic. Said differently, Fitch is simply catching up with the view of investors. Given there is unlikely to be any forced selling or other obvious flows resulting from the downgrade, the fallout should be limited. — Ian Lyngen and Ben Jeffery, BMO
After the 2011 downgrade, market participants were nervous that [it] could lead to forced selling as some investors’ mandates required only AAA-rated debt. However, most mandates turned out to either require an average rating or did not reference ratings when discussing US Treasurys. While a second downgrade pushes the average US rating down to AA+, we do not expect any significant forced selling. Given the likely lack of forced selling, investors should focus more on broader economic data momentum than on Fitch’s downgrade to the US credit rating. We expect upcoming payroll, inflation and other top-tier data to be much more impactful in driving rates and the curve. — Gennadiy Goldberg, TD
Tempest in a teapot? Beyond the bad optics and initial shock of the news, the downgrade is unlikely to trigger any large selling of Treasurys or a fundamental shift in investor behaviors. One reason is that investors have lived through the S&P downgrade in 2011 and remember coming away unscathed. Another might be that people have gotten used to an elevated level of deficit spending. Fitch’s rating change helps draw attention to the issue, but it does not constitute breaking news. In contrast to higher deficits incurred during COVID or other fiscal expansionary periods, the latest fiscal deterioration stems primarily from the Fed tightening monetary policy in response to high inflation, which ironically was a result of fiscal and monetary policies being too loose for too long. — Steven Zeng, Deutsche Bank
It is obvious that in the US and Globally there is no legitimate substitute for USTs. I own a whole lot of them in various forms. I started buying them in the 1950s (savings bonds when I was in fourth grade). My portfolio is built entirely on Treasury bonds. What made them great was all the things we read about here. But for us alive now, what they are now depended a great deal on the Treasury Accord signed in 1951. That deal made the Fed independent and allowed rates to fluctuate freely and be influenced by the Fed. When the Treasury issues bonds of various maturities, it auctions them at rates it sets and the actual market rate coordinates the contract proposal and the price buyers are willing to pay. The Treasury controls contract bond rates and maturities and the market buyers vote the actual rate through the prices they offer for a given security issue. When contract rates fall below market expectations the prices of existing bonds then fall as they have this year. My ability to profit handsomely from USTs for 25 years depended on the availability of bonds eschewed by the market at prices well below par. That made new securities out of these bonds and for me, at least, converted ordinary income to capital gains. When bought with borrowed capital this price action brought 100% returns to the table. Twenty percent was a piece of cake. Here’s the thing. After the accord the Treasury set rates as usual, but the Fed had independent tools it could use to control the operation of the financial system like reserve requirements and short-term lending rates to member banks. When they exercise those tools they can supersede the UST contract interest rates through market price changes forced by their policies. The irony to me is that as the Fed uses its policies to try to control system liquidity and reduce inflation, they totally blunt the value of existing investments in Treasury debt. I do understand this result and by not selling government securities with largish unrealized losses I can protect what was an acceptable contract interest distribution and actually see my income rise. However, those USTs don’t seem too great if you bought them in 2010.