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The Looming U.S. Debt Downgrade

Interest-Rates / US Debt Jul 06, 2011 - 02:30 AM GMT

By: Investment_U


Best Financial Markets Analysis ArticleTony Daltorio writes: An old saying, “Be careful what you wish for,” holds true in the investment world at times… such as now.

Over the past several days, the stock market enjoyed its best rally in months. This occurred on the back of news that the Greek crisis was resolved, at least temporarily.

But now that the crisis is past, what happens next?

Most likely the major global players in the bond and currency markets will shift their attention away from Europe, towards the elephant in the room.

That elephant in the room is the United States, its humongous debt and whether that debt will be downgraded from its current AAA rating.

Treasury Market

During the European crisis, the Treasury market once again served as a “safe haven” for many investors. But now with politicians in Washington bickering about raising the debt ceiling, some investors are leaving that “safe haven,” and Treasury yields are on the rise.

The question is whether the trickle of investors dumping Treasuries will turn into a flood.

There are certainly reasons to worry about the nation’s debt. The size of the U.S. Treasury market – the amount of debt issued –more than doubled since 2007. And the Congressional Budget Office (CBO) stated that the country faces a “daunting” budget outlook.

The ratio of U.S. debt to the size of the U.S. economy will approach 100 percent this year. The CBO projects that, without significant policy changes, the federal debt will reach nearly 200 percent of gross domestic product by 2035… a number very much like the one Greece faced.

Standard & Poor’s revised its outlook on the U.S. credit rating from “stable” to “negative” in April due to these projections of the long-term position of U.S. debt.

Overseas Rating Agencies

U.S. rating agencies are, however, behind their peers overseas on their outlook for U.S. debt. Several overseas debt-rating agencies have already downgraded U.S. debt.

The German credit-rating agency Feri downgraded U.S. debt in June from AAA to AA. Feri cited high public debt, inadequate fiscal measures and weaker growth prospects as its reasons.

The Chinese credit-rating agency Dagong downgraded U.S. debt to AA last summer. But now they’re taking it a step further.

Dagong now says that the United States already defaulted on its debt. A Dagong press release stated: “In our opinion, the United States has already been defaulting… Washington had already defaulted on its loans by allowing the dollar to weaken against other currencies – eroding the wealth of creditors, including China.”

The default comment is an exaggeration, but they certainly see the Federal Reserve’s policy of debasing the U.S. dollar over time.

Will a Downgrade Happen?

The question of a downgrade on U.S. debt by U.S. rating agencies isn’t simply a theoretical one. If it happens, it’ll cost investors a bundle.

According to a study from S&P’s Valuation and Risk Strategies, a research arm of Standard & Poor’s, if U.S. debt is downgraded, it’ll cost investors who own Treasuries a total of up to $100 billion.

Will a downgrade happen? Bill Gross of Pimco – perhaps the most famous bond investor ever – must think so. He was very vocal during recent months about the United States’ long-term fiscal position and turned negative on U.S. government debt.

However, most investors appear to be very comfortable about U.S. debt and aren’t worried at all about a downgrade. That’s why Treasury yields are so low.

They’re probably right. It’s doubtful that U.S. rating agencies will bite the hands that feed them.

Good investing,


Tony Daltorio

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