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By Steven C. Johnson
NEW YORK, July 26 A downgrade of the United
States' AAA credit rating is a bigger risk than a default and
could over time add up to 0.7 percentage point to bond yields,
members of a U.S. securities industry group said on Tuesday.
"That's on the order of $100 billion over time that we will
add to our funding costs," said Terry Belton, global head of
fixed income strategy at JPMorgan Chase. He was speaking on a
conference call organized by the Securities Industry and
Financial Markets Association, also known as SIFMA.
Over time, he said Treasury yields could rise 60 to 70
basis points on a credit downgrade -- "a huge number because
we're talking a permanent increase in borrowing costs."
That would make it more costly for consumers and business
to borrow money and could land the economy back in recession.
A default on the country's obligations would be even more
disruptive, call participants said, and could ripple across
financial markets, but was less likely.
The U.S. government hit its $14.3 trillion borrowing limit
in May and the Treasury said it will run out of money to pay
its obligations if the limit is not raised by Aug. 2.
An increase has been held hostage to political squabbling.
Republicans in Congress have refused to lift the debt ceiling
without a long-term deficit reduction plan but remain at odds
with the White House over the proper mix of spending cuts and
tax increases needed to do it.
Belton said the odds of a default were "virtually zero,"
noting that there were enough tax revenues to tide the
government over in case a deal is not struck by Aug. 2.
Missing an interest payment "would be a far worse scenario
and one I definitely think all members of the House and Senate
would want to avoid," said Mike Hanson, senior U.S. economist
at BofA-Merrill Lynch. He said it was "a low risk but,
unfortunately, it is not zero."
Even if the debt ceiling is lifted and default averted,
Standard & Poor's has said there's a one-in-two chance it could
still cut the U.S. credit rating without a credible deficit
Investors think that means savings of $3 trillion to $4
trillion over 10 years. Republicans and Democrats are pushing
competing plans, both of which fall short of that target.
In the short term, a downgrade would have a more subdued
impact on markets, Belton said, with bond yields likely to rise
five or 10 basis points.
Markets had feared a move to AA would spark forced selling,
but Belton said "most investors have indicated they would be
able to continue to hold them."
The "wild card" remains foreign demand over the longer run,
sine the U.S. depends heavily on overseas investors -- mostly
central banks -- to finance its deficit.
Belton said he expected demand for the $99 billion worth of
fresh two-, five- and seven-year Treasury debt this week to be
"on the weak side" and warned of even more concern if a debt
ceiling impasse forces Treasury to postpone future auctions.
He said an eight-day auction delay surrounding a debt
ceiling debate in 1995 cost the government 25 extra basis
points in financing costs.
(Additional reporting by Emily Flitter; Editing by James