Treasuries Are Still In a Class of Their Own Despite Fitch Cut

Ruth Carson and Matthew Burgess
Tue, August 1, 2023 
 

(Bloomberg) -- The US sovereign rating may have slipped but Treasuries remain a buy.

That’s the prognosis of strategists, who say US government bonds will still be the cornerstone of portfolios even after Fitch Ratings cut the nation’s AAA credit grade. The reason? There are few assets that can rival Treasuries’ status as the haven of choice.

“Because Treasury securities are such an important asset class, most investment mandates and regulatory regimes refer to them specifically, rather than AAA-rated government debt,” Goldman Sachs Group Inc. economists including Alec Phillips wrote in a note. “We do not believe there are any meaningful holders of Treasury securities who will be forced to sell due to a downgrade.”

The view was reflected in market moves on Wednesday as short-end Treasuries rose and a gauge of the dollar reversed a drop to edge higher. Taking the US out of the equation, investors have a limited pool of AAA-rated sovereign debt to choose from. Economies with the highest credit rating at S&P Global Ratings, Fitch and Moody’s Investors Service include Germany, Denmark, Netherlands, Sweden and Norway.

Such rating cuts “are a bit like these debt ceiling debacles — they can cause a bit of short term angst, but never amounts to anything much,” said Amy Xie Patrick, money manager in at Pendal Group. There needs to be a “credible alternative in terms of both being safe enough and large enough” to displace Treasuries, and there are no clear options now, she added.

Fitch cited the US’ ballooning fiscal deficits among the reasons for its decision, which echoes a a move made more than a decade ago by S&P Global Ratings.

2011 Downgrade

S&P’s rating cut in 2011 triggered a selloff in risk assets such as global equities, but boosted Treasuries as investors sought out havens. Yields on 10-year Treasuries slid 24 basis points on Aug. 8 that year, the first trading day after the S&P downgrade.

Fitch’s decision fueled a similar reaction on Wednesday, with Asian stocks declining and the two-year Treasury yield falling as much as three basis points. Benchmark 10-year US yields edged up one basis point to 4.03% after declining two basis points.

“Treasuries still provide the broad risk off hedge during periods of stress, which ironically, the downgrade may morph into,” said Marvin Loh, global macro strategist at State Street Corp. “When we look at 2011, credit and stocks initially were the most volatile following the S&P downgrade.”

“We do not believe the Fitch downgrade will have a huge market impact, as this brings the US into line with S&P ratings,” said James Wilson, senior portfolio manager at Jamieson Coote Bonds in Melbourne. “The financial system has weathered much bigger storms since then, and the bigger factor toward higher yields is the glut of Treasury supply that is set to come through the market with the larger coupon announcement.”

On Monday, the Treasury raised its net borrowing estimate for the July-through-September quarter to $1 trillion, more than some analysts expected and well above the $733 billion it had predicted in early May. The Treasury will preview its quarterly financing plans on Wednesday at 8:30 a.m. in Washington.

Borrowing Risk

Some commentators including Larry Summers and Mohamed El-Erian have criticized Fitch’s decision given US economic resilience. Summers, a former Treasury Secretary, said while there were reasons for concern about the long-run US deficit trajectory, the nation’s ability to service its debts isn’t in doubt.

Yields on 30-year US debt climbed eight basis on Tuesday and held at 4.10% in Asia Wednesday, around the highest level since November.

What Bloomberg Strategist Says...

“There shouldn’t be much lasting impact on Treasuries as Fitch put the US onto a stable outlook from negative. That means another move is very unlikely — its a one-and-done operation and marking to market with S&P’s AA+ rating.”
Mark Cranfield, Markets Live strategist

While some parts of the US curve face selling pressure, the consensus is that demand for Treasuries will persist as investors struggle to find other safe and liquid options to park their cash in.

“The Fitch downgrade will have minimal negative impact on the allure of US Treasuries,” said Chang Wei Liang, strategist at DBS Bank Ltd. in Singapore. In fact, it “may ironically support Treasuries buying on concerns of follow-on downgrades to US corporate credit.”

--With assistance from Michael G. Wilson.

Fitch cuts US credit rating to AA+; Treasury calls it 'arbitrary'

Tue, August 1, 2023 at 3:52 PM MDT·5 min read
By Davide Barbuscia

(Reuters) -Rating agency Fitch on Tuesday downgraded the U.S. government's top credit rating, a move that drew an angry response from the White House and surprised investors, coming despite the resolution of the debt ceiling crisis two months ago.

Fitch downgraded the United States to AA+ from AAA, citing fiscal deterioration over the next three years and repeated down-the-wire debt ceiling negotiations that threaten the government’s ability to pay its bills.

Fitch had first flagged the possibility of a downgrade in May, then maintained that position in June after the debt ceiling crisis was resolved, saying it intended to finalize the review in the third quarter of this year.

With the downgrade, it becomes the second major rating agency after Standard & Poor’s to strip the United States of its triple-A rating.

The dollar fell across a range of currencies, stock futures ticked down and Treasury futures rose after the announcement. But several investors and analysts said they expected the impact of the downgrade to be limited.

Fitch's move came two months after Democratic President Joe Biden and the Republican-controlled House of Representatives reached a debt ceiling agreement that lifted the government's $31.4 trillion borrowing limit, ending months of political brinkmanship.

"In Fitch's view, there has been a steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters, notwithstanding the June bipartisan agreement to suspend the debt limit until January 2025," the rating agency said in a statement.

U.S. Treasury Secretary Janet Yellen disagreed with Fitch's downgrade, in a statement that called it "arbitrary and based on outdated data."

The White House had a similar view, saying it "strongly disagrees with this decision".

"It defies reality to downgrade the United States at a moment when President Biden has delivered the strongest recovery of any major economy in the world," said White House press secretary Karine Jean-Pierre.

REPUTATIONAL DENT

Analysts said the move shows the depth of harm caused to the United States by repeated rounds of contentious debate over the debt ceiling, which pushed the nation to the brink of default in May.

"This basically tells you the U.S. government’s spending is a problem," said Steven Ricchiuto, U.S. chief economist at Mizuho Securities USA.

Fitch said repeated political standoffs and last-minute resolutions over the debt limit have eroded confidence in fiscal management.

Michael Schulman, chief investment officer at Running Point Capital Advisors said the "U.S. overall will be seen as strong but I think it’s a little chink in our armor."

"It is a dent against the U.S. reputation and standing," said Schulman.

Others expressed surprise at the timing, even though Fitch had flagged the possibility.

"I don't understand how they (Fitch) have worse information now than before the debt ceiling crisis was resolved," said Wendy Edelberg, director of The Hamilton Project At The Brookings Institution in Washington D.C.

Still, investors saw limited long-term impact.

"I don't think you are going to see too many investors, especially those with a long-term investment strategy saying I should sell stocks because Fitch took us from AAA to AA+," said Jason Ware, chief investment officer at Albion Financial Group.

Investors use credit ratings to assess the risk profile of companies and governments when they raise financing in debt capital markets. Generally, the lower a borrower's rating, the higher its financing costs.

"This was unexpected, kind of came from left field," said Keith Lerner, co-chief investment officer at Truist Advisory Services in Atlanta. "As far as the market impact, it's uncertain right now. The market is at a point where it's somewhat vulnerable to bad news."

LIMITED IMPACT

In a previous debt ceiling crisis in 2011, Standard & Poor's cut the top "AAA" rating by one notch a few days after a debt ceiling deal, citing political polarization and insufficient steps to right the nation's fiscal outlook. Its rating is still "AA-plus" - its second highest.

After that downgrade, U.S. stocks tumbled and the impact of the rating cut was felt across global stock markets, which were at the time already in the throes of the euro zone financial meltdown. Paradoxically, U.S. Treasuries prices rose because of a flight to quality from equities.

In May, Fitch had placed its "AAA" rating of U.S. sovereign debt on watch for a possible downgrade, citing downside risks, including political brinkmanship and a growing debt burden.

A Moody's Analytics report from May said a downgrade of Treasury debt would set off a cascade of credit implications and downgrades on the debt of many other institutions.

Other analysts had pointed to risks that another downgrade by a major rating agency could affect investment portfolios that hold top-rated securities.

Raymond James analyst Ed Mills, however, said on Tuesday he did not anticipate markets to react significantly to the news.

"My understanding has been that after the S&P downgrade a lot of these contracts were reworked to say 'triple-A' or 'government-guaranteed', and so the government guarantee is more important than the Fitch rating," he said.

Others echoed that view.

"Overall, this announcement is much more likely to be dismissed than have a lasting disruptive impact on the U.S. economy and markets," Mohamed El-Erian, President at Queens' College, said in a LinkedIn post.

(Reporting by Davide Barbuscia in New York, Jyoti Narayan in Bengaluru, Lewis Krauskopf and Saeed Azhar; Editing by Megan Davies, Arun Koyyur, David Gregoiro, Gerry Doyle and Sam Holmes)