Treasuries Proving Safer Than AAA Two Years After S&P Cut
Two years after Standard & Poor’s stripped the U.S. of its top rating, America’s credit quality is getting a boost from economic growth outpacing that of the 12 nations graded AAA.
The gap between Treasury five- and 10-year note yields is wider than that for the higher-rated sovereigns, showing fixed-income investors anticipate the U.S. will grow faster than its peers, according to data compiled by Bloomberg. Other measures also show the U.S. improving, as the cost to insure against default is the lowest since 2009, the dollar has risen the most since 2008 and the S&P 500 Index reached a record on Aug. 2.
Investors have rejected the notion that the U.S. is less creditworthy with gross domestic product forecast to grow 2.7 percent in 2014, the fastest of any Group of 10 nation, surveys of economists by Bloomberg News show, while the budget deficit is the least since 2008. While an S&P managing director said in March that other credit raters would “catch up” to its downgrade, the firm and Moody’s Investors Service have since changed their outlooks to “stable” from “negative.”
“The U.S. is really leading the way in the developed world for recovery,” Kathleen Gaffney, a money manager in Boston for Eaton Vance Corp. (EV), which oversees $261 billion, said Aug. 2 in a telephone interview. “We’re at an important inflection point where the economy really has the potential to pick up some steam.”
Yields on 10-year Treasuries ended last week at 2.60 percent, or 124 basis points more than five-year notes, the widest gap in two years. That compares with a 97 basis-point average for the 12 countries rated AAA by S&P, including a difference of 100 points in Germany, whose economy is forecast to expand 1.6 percent in 2014, data compiled by Bloomberg show.
Rather than a referendum on the credit quality of the U.S., the wider so-called yield curve reflects demand by investors for higher rates to own bonds instead of riskier assets with potentially greater returns, such as stocks, as the economy improves. The difference between five- and 10-year Treasury yields was 68 basis points, or 0.68 percentage point, at the end of 2008, according to data compiled by Bloomberg.
“The markets are telling us that we’re due for an acceleration over the next several quarters,” Carl Riccadonna, a senior U.S. economist in New York at Deutsche Bank Securities Inc., said in a telephone interview July 31. The firm is one of the 21 primary dealers that trade with the Federal Reserve.
That wasn’t the case for S&P when it cut the U.S. to AA+ on Aug. 5, 2011. The firm cited concern that spending reductions by lawmakers in order to raise the nation’s borrowing limit wouldn’t be enough to reduce the budget deficit and that the wrangling showed the U.S. becoming less politically stable.
The Treasury Department said S&P’s decision was flawed by a $2 trillion error. The ratings firm said there was no mistake and the discussion hinged on which baseline assumption should be used from the nonpartisan Congressional Budget Office.
U.S. general-government debt may rise to about 84 percent of GDP by 2015, S&P said July 10 in a report. That’s higher than the company’s 79 percent projection on Aug. 5, 2011.
S&P’s move roiled the markets, contributing to a global stock-market rout that erased about $6 trillion in value between July 26 and Aug. 12, 2011. Treasury 10-year yields fell as low as 1.67 percent that September from 2.41 percent on the day of the downgrade as investors sought a haven.
Markets have since recovered, as the economy gains strength following the worst financial crisis since the Great Depression and deficits start to shrink.
The dollar has gained 11 percent, according to the Bloomberg U.S. Dollar Index, which tracks it against the euro, yen, pound and seven other major currencies, since the cut. It has appreciated 4.3 percent in 2013, on pace for the biggest gain in five years.
The S&P 500 has surged 43 percent over the past two years, reaching an all-time high of 1,709.67 on Aug. 2, after the Labor Department said the economy added 162,000 jobs in July and the unemployment rate dropped to 7.4 percent. That’s the lowest since December 2008.
Yields on 10-year Treasuries (USGG10YR), the benchmark for everything from corporate bonds to mortgages, rose three basis points last week to 2.6 percent as the price of the benchmark 1.75 percent note due May 2023 fell 1/4, or $2.50 per $1,000 face value, to 92 23/32, according to Bloomberg Bond Trader prices.
Yields, while rising, compare with the average of about 6.7 percent since 1980, when the bull market in bonds began.
Ten-year notes yielded 2.63 percent today as of 2:44 p.m. in New York, according to Bloomberg Bond Trader prices.
After four years of budget deficits of more than $1 trillion as the government boosted spending to help the economy and bail out the banking system, the shortfall is now shrinking.
Higher tax revenue and lower spending mean the deficit will probably shrink to $378 billion, or 2.1 percent of GDP in 2015, from 3.4 percent next year, 4 percent in 2013 and 7 percent in 2012, according to the CBO.
“The U.S. fiscal problem is pretty much gone for quite some time,” Vincent Truglia, a consultant in New York who was a managing director of Moody’s sovereign risk unit for 11 years, said in an Aug. 1 telephone interview.
As the U.S. economic outlook has improved, rallies in riskier assets may have damped demand for Treasuries.
Investors in U.S. government securities have lost 2.6 percent on average this year, according to the Bloomberg U.S. Treasury Bond Index. (BUSY) Holdings by foreign investors rose 1.9 percent through May, slower than the 5.2 percent increase a year ago, Treasury Department data in July showed
While demand for fixed-income assets has diminished, appetite for the U.S. dollar has improved. Its share of global foreign-exchange reserves rose to 62 percent on March 31 from a low of 60 percent in June 2011, according to International Monetary Fund data.
Credit-default derivatives used to bet on creditworthiness and insure against default signal the U.S. is safer than its top-rated developed market counterparts.
Swaps tied to the U.S. are priced at about 22 basis points, the lowest since 2009 and less than half the 55 basis points when S&P downgraded the nation, according to CMA data compiled by Bloomberg. Swaps linked to Germany are 26 basis points, while those for Australia are 49.7 basis points.
“U.S. policy makers may have stumbled into the right mix of fiscal drag without excessive austerity,” Jake Lowery, a money manager at ING U.S. Investment Management, which oversees $120 billion of fixed-income from Atlanta, said in a July 31 telephone interview.
Downgrades don’t always result in higher borrowing costs. In 53 percent of 32 changes in credit outlook last year, yields on government securities moved in the opposite direction from what ratings suggested, according to data compiled by Bloomberg and published in December on Moody’s and S&P grades.
Bond markets shouldn’t be expected to react when a country’s credit rating is changed because sovereign-debt yields reflect more than just the credit risk on which rankings hinge, such as the outlook for changes in interest rates, according to Fitch Ratings, which has maintained its top grade for the U.S., with a negative outlook.
The chief credit officer Moody’s, Richard Cantor, said last year that “we have only one objective, which is to assign ratings that are indicative of the relative risk of default and losses.”
Political wrangling over the nation’s borrowing limit continues. Treasury Secretary Jacob J. Lew told Congress on Aug. 2 that he’s extending a measure that enables the U.S. to stay under the $16.7 trillion debt ceiling, as the Obama administration and Republican lawmakers remain in a stalemate on raising the limit.
Lew told congressional leaders in a letter that he is extending until Oct. 11 a “debt-issuance suspension period” that was to expire last week. The step, one of the so-called extraordinary measures the Treasury takes allowing it to maintain its borrowing ability, doesn’t necessarily mean the debt limit will be reached Oct. 11, the last day Congress is in session before a Columbus Day recess.
“I respectfully urge Congress to protect America’s good credit and avoid the potentially catastrophic consequences of failing to act by increasing the debt limit in a timely fashion,” Lew said in the letter, which was released by the Treasury Department.
As recently as five months ago, S&P suggested that it felt the nation’s creditworthiness was in doubt. John Chambers, managing director of sovereign ratings at the firm, told Bloomberg Television on March 1 that “they’ll catch up to us,” referring to other credit-rating firms.
S&P changed its outlook for the U.S. to “stable” in June from “negative,” citing “tentative improvements” in the debt burden. Moody’s did the same a month later, after having called in May for more deficit reduction measures.
“Though we had been waiting for perhaps more action on the fiscal front, even without that the debt trajectory was supportive of a Aaa rating,” which is the highest Moody’s grade, Steven Hess, the firm’s senior vice-president and lead sovereign analyst for the U.S., said in a July 19 telephone interview.
None of this matters to the bond market.
“The world really doesn’t care that the government isn’t rated AAA by all three raters,” James Sarni, senior managing partner in Los Angeles at Payden & Rygel, which oversees $84 billion, said in a July 31 telephone interview. “Our markets are more stable, they’re more liquid and they’re very large. While we may see somewhat slow growth in the U.S., on a relative basis the U.S. is going to be a pretty good place to be.”
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