US downgrade – better late than never, say asset managers

Asset managers say ratings agencies gave America “the benefit of the doubt for too long” before Standard & Poor’s finally stripped Washington of its coveted AAA rating late on Friday.

S&P now rates US sovereign AA+, with negative outlook. Moody’s and Fitch earlier reaffirmed their AAA rating of US sovereign debt, while Germany’s Feri already downgraded the US.

Fund managers dubbed S&P’s move “humiliating” for the US government and President Barack Obama, and said it would have significant implications for the US dollar, and confidence of investors, including most importantly China.

But they added there were no alternatives to Treasuries, at present at least, for investors to use to hedge out risk in such deep and transparent markets.

China’s official news agency Xinhua reacted with anger on Friday, scolding the US for its profligate spending and the political gamesmanship before lawmakers finally agreed a raising of the $14.3trn debt ceiling last week.

Asian markets reacted badly to the ratings cut, and eurozone crisis, overnight. Japan’s Nikkei 225 fell 2.2%; the Topix dropped 2.3%; while the Hang Seng was off 2.2%.

Bill Gross, Pimco’s founder and long-time US debt bear, told Bloomberg yesterday: “I think S&P has demonstrated some spine; they finally got it right.”

Dominic Rossi (pictured), global CIO, equities, at Fidelity International, said S&P’s decision was an “additional piece of bad news which will have an immediate effect on confidence generally which will feed through to the economy and equities.

“Relationships will be strained between the US and key trading partners, especially China who are major holders of US government bonds.”

He predicted S&P’s decision also makes it impossible for candidates in America’s presidential election next year to avoid the economy and debt mountain.

“In its statement, S&P highlighted the weak political process as part of its rational and is poised for a second downgrade within two years. This will loom over the election, and each candidate will be scrutinised on fiscal policy, with the prospect of a further downgrade as they enter office.

“The decision is of huge significance. It is humiliating for the government and it is an indictment of the Federal system. It also undermines the world reserve currency, and raises the prospect of stagflation.

“Good can come from the S&P downgrade, if this humiliation stirs Washington into action. The risk is they will focus on the AAA ratings from the other agencies, and bad-mouth S&P instead.”

BlackRock said in a statement the US demotion from AAA – the first time the US has suffered this – “reflects facts that have been well known to the market for some time. It does not imply a fundamental increase in risk, and we don’t believe that investors should change their behaviour based solely on the downgrade”.

However, BlackRock added the cut “may provide a signal to some investors to reassess their risk appetite”.

The asset manager is prepared for more downgrades this week of the various other issuers and issues including the GSEs and some corporates, which derive their rating from that of the US government.

The manager added: “The weakness in labour markets, when combined with only modest levels of growth, argues for a high likelihood that the Federal Reserve will maintain its Fed Funds policy range at historically accommodative levels for at least another year and perhaps through 2012.

“Moreover, we believe the Fed will want to continue supporting the recovery in any manner it can in light of an extraordinarily anaemic real growth rate of 0.4% for the first quarter of 2011, revised downward from 1.9%, and a below consensus estimate of 1.3% for the second quarter.

“Nonetheless, we think it is vital to underscore the fact that the US Treasury sector – and to a slightly lesser extent agency-backed mortgage backed securities – remains the largest and most liquid fixed income market in the world with the greatest degree of price transparency and few genuine alternatives.

“The vast majority of investors will continue to utilize the Treasury yield curve as an effective credit risk-free benchmark against which credit spread issues can be judged. Treasuries will also continue to see a strong bid from institutional investors of all kinds including banks and will continue to serve their traditional role as a hedge to risk assets.”

“While a time may come when the credit risk-free status of Treasury bonds is diminished by continued policy missteps, we do not believe that the S&P downgrade signals that this moment has come now.”


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