How to read a rating downgrade

As Barack Obama and S&P continue their public spat over the ratings agency’s downgrading of America’s Triple A credit rating, just how much importance should advisers place on a downgrade?

Ted Scott, Director of Global Strategy at F&C, advises taking a step back to consider what has actually changed and whether the sharp decline in risk assets represents “a buying opportunity or is the beginning of a more pernicious move.”

Against the current backdrop of heavy falls in share prices, Scott says the rating downgrading of US government debt from AAA to AA+ was not totally unexpected.

S&P had already threatened a downgrade if the US did not raise its debt ceiling enough to present a credible fiscal consolidation plan to address the huge public sector deficit.

However, the announcement still came as a nasty surprise coming just amid such turbulence on world markets.    

“The downgrade is important symbolically but is much less significant than what is going on in the eurozone debt crisis,” says Scott.

“It is a loss to the US's prestige and a sign of the times that the financial power base is gradually shifting from the West to the East, but it is unlikely to have much effect on what matters: the yield on Treasury bonds themselves and the dollar.”

Scott makes the case that, paradoxically, US Treasury bonds may be seen as a greater safe haven as the risks of a global sovereign debt crisis and recession have materially increased in recent days.

“Indeed, the initial reaction has been for Treasury bonds to strengthen slightly in the open market.

The main short term concern is what the knock-on effect of the lower rating will be to US financial institutions and whether they will also be downgraded.” 

Looking to the longer-term, Scott says the downgrade carries more significance as it underlines the fragility of the US public sector balance sheet and how difficult it will be to restore financial health to such an over indebted country.

http://fandc.com