This market has shrugged off basically everything thrown at it: unemployment, consumer sentiment, sovereign debt crises in Portugal, Spain, Italy, Ireland and Greece, the list goes on and on. The latest is the concern that the US and other large Western countries like Germany, France, and the UK would lose their gold plated AAA debt rating.
In the most recent Moody’s quarterly “Aaa Sovereign Monitor” report, they cite concerns about “debt affordability” and hint that it is possible for the unthinkable to happen. This of course was picked up by all major media outlets and the echo chamber went into full effect.
I’m sure that a lot of people who want to believe in the bear case will jump on this because it makes a lot of sense. But let me explain why I think this is nonsense and just another brick in the wall of worry.
First of all, why in the world would anyone listen to Moody’s? or any other rating agency? If anyone had a doubt before the credit crisis, their behavior as the courtesans of the sub-prime fiasco cemented the fact that their opinion has absolutely zero relevance to actual market reality.
Second, if you actually read what Moody’s wrote in their report you realize that the media has exaggerated to a large extent their message. First of all, the title of the report is, “AAA Governments Have the Capacity to Rise to the Challenges They Face”. Beyond that, here are some excerpts:
The ratings of all Aaa governments are currently well positioned despite their stretched finances…
The recovery that has taken hold across the global economy remains fragile in several of the large advanced economies, most of which have also implemented the most aggressively expansionary fiscal and monetary policies.
…debt affordability — i.e. the ratio of interest payments to government revenues — indicates that the ratings of all Aaa governments remain well positioned, despite the reduction in their ‘distance-to-downgrade’ and the widening of tail risk…
…the Aaa ratings of the UK and the US, whose debt affordability is currently the most stretched, continue to be supported by substantial ‘debt reversibility’…
Debt reversibility is where a government is able to heal itself, fiscally, after an economic shock. So basically there is nothing new here. Moody’s is saying that things got really bad, now they are a little better but we have to be careful going forward because things are really uncertain at this point. But let’s say that the exaggeration of this message is true and the US will lose its vaunted AAA rating. What will that mean exactly?
The assumption obviously is that international lenders would require a higher interest rate to lend to the US because of this alleged downgrade. But is that true?
To find out, listen to David Rosenberg. He continues to be a growling bear, and once again finds himself mostly alone, just like back in 2007. But he does not succumb to this alluring argument and instead marshals facts instead of opinion and emotion:
Canada was pushed out of AAA on October 14, 1992 and did not regain that status until July 29, 2002 — and over that time frame, the yield on the benchmark 10-year Government of Canada bond tumbled from 7.84% to 5.29% (that 255bps decline compared with a 189bps decline in comparable U.S. yields over that time frame).
Japan lost its AAA rating in February 2001 and over the next three years, the 10-year JGB yield still ended up declining almost 100bps to the lows two years later and the yield is still lower today than it was at the time of the downgrade.
Screaming headlines that warn of the US losing its status symbol of the highest debt rating may grab attention but just like the interest rate myth, I think we can safely consider this a non-issue. But as long as people view it as a concern, it will just be yet another brick in the wall of worry that the bull will climb - to the astonishment of almost everyone watching.
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