Pimco’s El-Erian Says U.S. Downgrade Casts Doubt on Other AAA Countries

Standard & Poor’s reduction of the U.S. credit rating may make it harder for other top-rated countries to keep their AAA ranking, according to Mohamed A. El- Erian of Pacific Investment Management Co.

The downgrade by S&P “may well raise questions about other members of the dwindling AAA club,” El-Erian, 52, the Newport Beach, California-based chief executive officer and co-chief investment officer at Pimco, the world’s largest manager of bond funds, wrote in an e-mail today. S&P gives 18 sovereign entities its top ranking, including Australia, Hong Kong and the Isle of Man, according to a July report.

S&P lowered the U.S. one level to AA+ while keeping the outlook at “negative” as it becomes less confident Congress will end Bush-era tax cuts or tackle entitlements. The rating may be cut to AA within two years if spending reductions are smaller than the ones agreed to, interest rates rise or “new fiscal pressures” result in higher general government debt, the New York-based firm said yesterday.

Moody’s Investors Service and Fitch Ratings affirmed their AAA credit ratings on Aug. 2, the day President Barack Obama signed a bill that ended the debt-ceiling impasse that pushed the Treasury to the edge of default. Moody’s and Fitch also said that downgrades were possible if lawmakers fail to enact debt reduction measures and the economy weakens.

The U.K., which is estimated to have debt to GDP this year of 80 percent, 6 percentage points higher than the U.S., also has the top credit grade. In contrast with the U.S., its net public debt is forecast to decline either before or by 2015, S&P said in the statement yesterday.

New Zealand

New Zealand is the only country other than the U.S. that has a AA+ rating from S&P and an Aaa grade from Moody’s. Belgium has an equivalent AA+ grade from S&P, Moody’s and Fitch.

“Investors should be cautiously positioned as the global economy and markets face major uncertainties,” El-Erian wrote. “The downgrade will be a further headwind to growth and job creation in the U.S.”

About $1.87 trillion has been erased from the value of U.S. equities since July 22, including the 4.8 percent plunge by the S&P 500 on Aug. 4 that was the biggest drop since February 2009. U.S. stocks fell the most in 32 months this week, erasing the S&P 500’s 2011 advance, as investors fled equities amid signs that the economy is stalling. Treasuries rose this week, pushing the two-year note yield to a record low.

‘Unthinkable’

“The once-unthinkable loss of the AAA rating will constitute a further hit to already fragile business and consumer confidence,” El-Erian wrote.

The Thomson Reuters/University of Michigan final index of consumer sentiment fell in July to the weakest since March 2009. Gross domestic product climbed at a 1.3 percent annual rate in the second quarter following a 0.4 percent gain in the prior quarter that was less than earlier estimated, Commerce Department figures showed July 29. Still, American employers added more jobs than forecast in July and the unemployment rate fell for the first time in four months, the Labor Department said yesterday.

El-Erian also said that Americans will face “higher credit costs” over time. JPMorgan Chase & Co. estimated that a downgrade would raise the nation’s borrowing costs by $100 billion a year. A U.S. credit-rating cut would likely increase Treasury yields by 60 basis points to 70 basis points over the “medium term,” JPMorgan’s Terry Belton said on a July 26 conference call hosted by the Securities Industry and Financial Markets Association.

Rally Snuffed

The S&P 500 climbed as much as 1.5 percent in the first five minutes of trading yesterday before turning lower as speculation swirled through the market that S&P was preparing to strip the U.S. of its AAA rating. The index closed 0.1 percent lower at 1,199.38.

Pimco’s $245.5 billion Total Return Fund, managed by Bill Gross, has returned 4.15 percent this year, beating 40 percent of its peers, according to Bloomberg data. Gross boosted his Total Return Fund’s investment in U.S. government securities to 8 percent of assets in June from 5 percent in May, according to Pimco’s website last month. Bonds in developed markets outside the U.S. rose to 13 percent of holdings from 10 percent. Cash and equivalents dropped to 29 percent from 35 percent.

To contact the reporter on this story: Rita Nazareth in New York at rnazareth@bloomberg.net

To contact the editor responsible for this story: Michael P. Regan at mregan12@bloomberg.net

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