U.S. Debt May Rise as D.C. Dysfunction Draws Downgrade, UBS Says

Treasury yields, now at almost eight-month highs, are set to reverse course as political wrangling in Washington and a “likely” U.S. credit downgrade drive investors to the safety of government debt, according to UBS AG.

“Treasuries are likely to rally over the next month or two,” Mike Schumacher, head of global-rates strategy at UBS, said in a Bloomberg Television interview on “Market Makers” with Erik Schatzker and Stephanie Ruhle. “The market doesn’t know how the political risk plays out.”

A downgrade from Moody’s Investors Service could come as early as March, Schumacher said, as political posturing in Washington continues after the U.S. reached its debt ceiling Dec. 31. Without an extension of the spending limit, the Treasury will exhaust measures to finance the government as early as mid-February, according to the Congressional Budget Office.

A Jan. 1 deal that averted more than $600 billion in federal tax increases and spending cuts didn’t provide “meaningful improvement” in the U.S. debt burden, leaving the nation’s Aaa rank at risk, Moody’s said on Jan. 2. The U.S. budget package passed by Congress won’t reduce deficits enough to avoid a sovereign-rating downgrade, said Moody’s.

The U.S. is moving to cut some $1.2 trillion of spending over the next decade. As part of last week’s deal, Congress delayed by about two months the $109 billion of reductions that were to begin this month.

Negative Outlook

The ratings company assigns the U.S. its top Aaa ranking with a negative outlook on the grade, as does Fitch Ratings.

Standard & Poor’s cut the U.S. rating one step to AA+ on Aug. 5, 2011, with a negative outlook.

The benchmark 10-year yield declined one basis point, or 0.01 percentage point, to 1.89 percent as of 12:15 p.m. New York time, based on Bloomberg Bond Trader prices. The yield rose to 1.97 percent on Jan. 4, the most since April 26. The 1.625 percent note maturing in November 2022 rose 2/32, or 63 cents per $1,000 face amount, to 97 19/32. The 30-year bond yield fell one basis point to 3.09 percent.

If a downgrade comes, “very few investors would make any meaningful shift out of the U.S.,” Schumacher said. UBS is one of 21 primary dealers that trade directly with the Federal Reserve.

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