August 2, 2011 / 11:53 AM / 8 years ago

Analysis: If U.S. debt is downgraded, will anyone care?

NEW YORK (Reuters) - The United States could lose its triple-A credit rating from at least one rating agency this year, raising the question: Who cares?

Clouds pass over Capitol Hill, August 1, 2011. REUTERS/Joshua Roberts

Strange as it may sound, a downgrade could resound in financial markets more with a whimper than a bang.

As debate raged in Washington over raising the debt ceiling and avoiding a default, markets had plenty of time to factor in the thinking of Standard & Poor’s, Moody’s and Fitch on a potential downgrade.

“Market participants have the same information that ratings agencies do,” said Michael Moran, chief economist at Daiwa Securities America in New York. “(That information) should already be reflected in interest rates.”

Two ratings agencies, elected by no one, said $4 trillion in deficit-cutting measures would allow them to confirm the U.S. triple-A rating. Lawmakers, who in contrast must answer to American voters, agreed on less than $2.5 trillion in budget cuts, only some of them immediate.

That means S&P could downgrade U.S. ratings in the next few days or weeks. Moody’s would likely confirm U.S. ratings, but slap a negative outlook on them, a sign of a possible downgrade in the next 12 to 18 months.

Still, historical experience suggests a downgrade would produce none of the bond-market angst some fear. Japan lost AAA status more that a decade ago and it has some of the lowest interest rates in the developed world.

As it was with Japan, the big issue for markets is the weak U.S. economy, which could slow further due to the spending cuts in the deficit-cutting deal.

This fiscal restraint could curb spending, job growth and inflation — the biggest drivers of bond yields.

Also, investors see the United States in a much different situation than crisis countries such as Greece. Awash in debt though it is, the United States is still able to pay its bills while Treasury bonds remain liquid and in demand.

The bond market is the ultimate arbiter of sovereign debt worries, and low U.S. yields suggest none of the anxiety that sent Greek yields soaring during that country’s fiscal crisis.

Benchmark 10-year yields now stand at 2.74 percent, which is just 0.7 percentage point from the all-time low and follows weeks of high-tension haggling and fears political paralysis could result in a default.

Still, a U.S. debt rating cut to AA-plus from AAA by Standard & Poor’s is “the market’s base case at the moment,” said Krishna Memani, fixed-income director at OppenheimerFunds.

While bonds have done well, stocks and the dollar suffered during the debt impasse amid fears the political conflict would make it impossible to reach a deal to avoid default.

Some are skeptical of the heightened ratings rhetoric.

The Obama administration has grown frustrated with Standard & Poor’s during the debt limit crisis and accused the ratings agency of changing the goal posts in its downgrade warnings.

Since October, S&P has accelerated its deadline three times for when it might downgrade the United States’ credit rating.

“Based on the comments Standard & Poor’s has made so far, they’ve backed themselves into a corner, making it very likely that we could see a downgrade,” said Oliver Pursche, president at Gary Goldberg Financial Services in Suffern, New York.

But a well-telegraphed U.S. debt ratings downgrade pales in significance with evidence of flagging economic growth, including Monday’s report showing U.S. manufacturing grew at its slowest pace in two years in July.

Consequently, a U.S. debt ratings downgrade would not cause yields to skyrocket, limiting the so-called knock-on effects on other interest rates, such as those on mortgages.

“We will see first-hand what it means to balance the budget and from an economic standpoint, it ain’t gonna be a pretty picture,” said David Rosenberg, chief economist and strategist at Gluskin Sheff in Toronto.

A fall in “discretionary” government spending to zero would lead to “a very deep recession,” Rosenberg said.

Then, whether they are rated AAA or AA+, “you will find a lot of people buying Treasuries because that’s what people will want to own when we go to a negative growth rate,” he said.

Editing by Dan Grebler

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