Tuesday, August 6, 2013

Revisting S&P's Downgrade of U.S. Debt


Two years ago, on August 5, 2011, the bond credit rating agency Standard & Poor's downgraded the debt of the United States from AAA to AA+.

S&P was dismayed with the huge budget deficits that our government was running, and the high degree of political rancor in Washington. The downgrade occurred just a week after the S&P 500 lost -7.2%, which was its largest weekly sell-off in 32 months.

The bond market, however, was largely unmoved by the action of the country's largest credit rating agency.  Rather than flee the U.S. Treasury market, investors bid up the prices of government debt.  Within a year, the yield on the 10-year Treasury note had dropped by over 100 basis points.

Today, however, yields are almost exactly where they were two years ago, except that interest rates have been rising in anticipation of a stronger economy rather than any perceived fiscal credit weakness.

While our deficit problems are far from solved, the fiscal budget deficit has declined from almost 10% of GDP in 2009 to 5.5% of GDP today.  The Congressional Budget Office now estimates that the fiscal budget deficit will be the lowest in 5 years, helped by a combination of higher tax receipts and lower expenditures.

Here's what the Washington Post wrote yesterday afternoon in an article titled "S&P screwed up when it downgraded U.S. credit 2 years ago: here's proof":

Two years ago today, Standard & Poor’s downgraded the credit rating of the United States, from AAA to a mere AA+. It was a psychological gut-punch, coming on the heels of a divisive standoff over raising the federal debt ceiling in which some Republican members of Congress threatened to allow the nation to tumble into default.

It also looks, with the benefit of hindsight, like the wrong call. Yes, the U.S. government might be dysfunctional. But over the past two years, prices in bond markets look like a wholesale rejection of the S&P thesis.

http://www.washingtonpost.com/blogs/wonkblog/wp/2013/08/05/sp-screwed-up-when-it-downgraded-u-s-credit-2-years-ago-heres-proof/



The real problem with the S&P action two years ago was that it simply did not make sense, then or now.