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Almost nobody really expects the US to default on its debts as a result of this interminable debt-ceiling brouhaha, which helps explain why markets aren’t exactly beside themselves with terror today.
But barring some sort of miraculous intervention, it seems increasingly likely that politicians will wind up kicking this can down the road, thereby failing to satisfy all the major credit-rating agencies that the US will get its fiscal house in order any time soon (whether that’s really a necessary fight to be having now, with economic growth anemic, is a whole other question that’s not being asked very much).
So it seems likely that the US is at serious risk of somebody taking away its AAA credit rating very soon, which could actually get the market’s attention.
But the negative impact of a downgrade on US financial markets could be short-lived, if history is any guide. (In fact, Jim Rogers suggests the market has already accepted the US as a less-than-AAA credit.)
Standard & Poor’s, which has recently menaced Uncle Sam with the downgrade stick, cut Japan’s rating not once but three times between 2001 and 2002. The result was not a market freakout, not soaring government borrowing costs, but rather a steep decline in borrowing costs as yields fell, note BMO Capital Markets analysts:
A rating downgrade does not portend the end of the world. While we do not dismiss the significance of a downgrade from AAA to AA, that would still leave the US credit rating (according to S&P) with a “VERY STRONG capacity to meet its financial commitments…and it differs from the highest rated obligors only in small degree.”
Furthermore other countries that in the past have lost their AAA and dropped to AA, such as Canada, Australia and Japan seem to have been only marginally impacted. More importantly, Canada and Australia were able to regain their AAA rating after several years of fiscal discipline.
But a key question in many investors' minds is what impact will a downgradehave on interest rates. Taking Japan as an example the answer is that a downgrade may have no impact on rates. Indeed, Japan was downgraded by S&P from AAA to AA+ on February22 2001 and the 10-yr rate moved 24bps lower the following week.
Similarly when both S&P and Fitch lowered Japan's credit rating to a AA in November of 2001 the 10-year rate traded relatively flat to lower in the weeks following the downgrades.
Ten years have passed since Japan lost its AAA rating and while its 10-year yield still remains close to 1% its currency has not been negatively impacted, but rather it is near the strongest levels of the decade.
Therefore while a credit downgrade would create a long period of uncertainty before all the implications became clear, there is precedent to suggest that rates may be not spike higher as some market participants are expecting and the world's reserve currency may remain unaffected.
The usual caveat here is that the US is not Japan. But this history suggests that, barring some short-term market turmoil, the outlook for inflation will probably have a bigger impact on government borrowing costs than rating agency opinions.
And US debt, and the US currency, can remain safe havens, under the right circumstances — for example, if they remain the least-ugly dog in the world’s ugly-dog contest.
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MarketBeat looks under the hood of Wall Street each day, finding market-moving news, analyzing trends and highlighting noteworthy commentary from the best blogs and research. MarketBeat is updated frequently throughout the day, helping investors stay on top of what's happening in the markets. The Wall Street Journal's Chief Markets Commentator Dave Kansas and MarketBeat lead writer Mark Gongloff spearhead the MarketBeat team, with contributions from other Journal reporters and editors. Have a comment? Write to marketbeat@wsj.com or write Dave at dave.kansas@wsj.com or Mark at mark.gongloff@wsj.com.
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