Monday, August 8, 2011

S&P downgrade of US Treasury debt

S&P downgraded US Treasury debt to AA+ with a negative outlook. The short-term rating was held at A-1+. The reaction in Treasuries has been muted because the flow to cash and away from equities continues. It takes years to get back a AAA rating.

It is amazing that the messenger has been shot over this downgrade given they told the markets it would happen if there was not a credible multi-trillion debt reduction plan. Th ratings by Moody's and Fitch were reaffirmed on August 2. S&P further double downed by saying that if there was not further movement on debt reduction, it would look to a further downgrade.

Interest rates for sovereign debt are determined by economic growth and expected inflation and to a lesser degree credit risk. Hence, the bond rally with the downgrade. There are also limits to where investors may go in the short-run. However, the credit risk may not be the main concern. Investors may expect higher inflation as a debt solution.

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