What a Ratings Downgrade Would Mean for Investors

Is it possible that the very place investors would rush to if the U.S. government was downgraded by a major ratings agency would be ... the U.S. government? It may sound counterintuitive, but if an influential ratings agency like Standard & Poor's were to actually downgrade the U.S. government, experts say investors would seek safety, probably in the form of U.S. treasuries, long known as one of the safest places for investors to park their money.

"Investors rate investment possibilities on a curve ... so while treasuries may not look good, as long as it looks better than the rest, even a downgrade doesn't necessarily mean, in the short run, a flight away from treasuries," says Veronique de Rugy, a senior research fellow at the Mercatus Center at George Mason University in Fairfax, Va. The United States has its fair share of problems, de Rugy says, but other European countries, most notably nearly bankrupt Greece, are much worse off at the moment.

[In Pictures: 6 Numbers Every Investor Should Follow.]

No other bond market in the world is as large, liquid, and transparent as the U.S. treasury market, even if the U.S. government's credit rating is downgraded, says Jan Randolph, director of sovereign risk at forecasting firm IHS Global Insight based in Englewood, Colo. And because of that status, nothing catastrophic is expected to happen if the United States is downgraded one level from AAA to AA+. "A single notch downgrade may not necessarily have a big material impact," Randolph says. "America would still be able to issue debt, command reserve currency status, and have low interest rates, although you might expect those to go up a little." Generally, when a bond of any type is downgraded, the yields on it move higher because the ratings agencies are essentially assigning more risk to it. But treasuries are unique because they're still the traditional safe haven that investors choose in times of market turmoil.

Following a downgrade, Ray Humphrey, senior vice president at Hartford Investment Management Company in Hartford, Conn., says he would expect volatility to pick up in the stock market, but only for a few days. "It's going to be a bump in the road," Humphrey says.

In terms of safe alternatives to treasuries, experts say there aren't many. What comes to mind first are other high-quality bonds that carry top-notch ratings. "We've actually thought that high-quality sovereign debt such as Canadian sovereigns or German bunds would be a nice place to hide in better-quality sovereigns," Humphrey says. Both those countries also garner top-notch ratings from the ratings agencies. However, depending on how big the fallout is in the stock market, treasuries may still be the best opportunity. "You would expect that those two markets would do at least marginally better in the scenario that the U.S. is downgraded by one notch, but if equities really start to tank, I suspect the U.S. is probably going to be the safe haven place to be," Humphrey says.

[See 3 Safe-Haven Alternatives to Treasuries.]

In addition, real assets like precious metals also stand to benefit from more uncertainty surrounding currencies. Investors generally flock to precious metals like gold in times of crisis because it's seen as a type of alternative currency. An ounce of gold now trades near record highs of around $1,600. While investors have been "rather wishy washy about their views on equities" over the last two weeks, flows into commodities and precious metals funds have been fairly consistent, says Lipper Senior Analyst Jeff Tjornehoj. In the last two weeks ending July 20, investors have injected more than $800 million into commodities precious metals funds, according to Lipper.

[See What Happened to the Muni Bond Blowup?]

Further down the road, Humphrey says his biggest concern is a spike in interest rates. While investors may flock to treasuries in the near term, if nothing is done about the ballooning budget deficit, he says the country's credit rating could continue to erode, which would result in higher interest rates. This is worrisome because treasury rates are one of the benchmark rates in the bond market. A number of rates, including mortgage rates, are tied to the benchmark treasury yield. "If all of a sudden our credit metrics start to move a little bit further south ... you could start to see the cost of financing on mortgages start to get very prohibitive for the average family," he says. That could spell trouble for an already weak housing market.

What's more, the U.S. government doesn't really control its own destiny when it comes to the treasury market. "Half the U.S. treasury market is held by foreigners now, principally Asian [countries] ... and how they see things is increasingly important," Randolph says. The Chinese government alone holds more than $1 trillion worth of treasury securities. If countries like China were ever able to find another place to invest their money, that's when investors should really begin to worry about higher interest rates.

Twitter: @benbaden

Loading...

Editor’s note:Yahoo Philippines encourages responsible comments that add dimension to the discussion. No bashing or hate speech, please. You can express your opinion without slamming others or making derogatory remarks.

  • ‘Get SAF 44 killers before BBL passage’
    ‘Get SAF 44 killers before BBL passage’

    Lawmakers are demanding the arrest of the Moro Islamic Liberation Front (MILF) fighters involved in the killing of 44 policemen in Mamasapano before the approval of the proposed Bangsamoro Basic Law (BBL) in Congress. Cagayan de Oro Rep. Rufus Rodriguez, chairman of the 75-member ad hoc committee in the House of Representatives deliberating on the BBL, prodded the Department of Justice (DOJ) to speed up its investigation and file charges against the MILF guerrillas as the Aquino administration …

  • Pinoys dance for Earth Hour
    Pinoys dance for Earth Hour

    The Philippines once again displayed its support Saturday night for the worldwide observance of Earth Hour by hosting a dance party after turning the lights off from 8:30 to 9:30 p.m. to save energy and make a statement on various environmental issues. The World Wide Fund for Nature (WWF) said widespread participation proved anew that no individual action on climate change is too small and that no collective vision is too big with celebrations in over 7,000 hubs in 170 countries. The WWF said …

  • Phl offers Sabah to win Malaysia’s support for UN case vs China
    Phl offers Sabah to win Malaysia’s support for UN case vs China

    The Philippines has offered to downgrade its claim on Sabah in exchange for Malaysia’s support for its case against China before the United Nations. The quid pro quo was contained in a note verbale the Department of Foreign Affairs (DFA) handed to a representative of the Malaysian embassy last week, a week after the visit of Malaysian Defense Minister Dato  Seri Hishammuddin Tun Hussein. The note verbale, a copy of which was obtained by VERA Files, referred to the May 6, 2009 joint submission …

  • Maysak to enter Phl Wednesday
    Maysak to enter Phl Wednesday

    A typhoon with international name Maysak is expected to enter the Philippine area of responsibility (PAR) on Wednesday and bring rains over Northern Luzon by weekend, the state weather bureau said yesterday. Aldczar Aurelio, weather forecaster of the Philippine Atmospheric, Geophysical and Astronomical Services Administration (PAGASA), said the typhoon was 2,810 kilometers east of Mindanao as of 10 a.m. yesterday. “This typhoon is still too far to affect any part of the country,” the weather …

  • Nonviolent disciplining of kids pushed

    Child rights advocates called on senators to pass and strongly endorse a law that will institutionalize positive and nonviolent methods of disciplining children.The Child Rights Network (CRN), Plan International Philippines (PIP), Philippine Legislators’ Committee on Population and Development (PLPCD), and Lihok Pilipinas Foundation led the call for the enactment of the Positive Discipline Bill.Several Quezon City Council members led by Majority Floor Leader Jesus Manuel Suntay, Victor Ferrer …

  • Method to their madness

    [caption id="attachment_256768" align="alignright" width="212"] Illustration by Rod Cañalita[/caption] EMMANUEL PORTUGAL Country Manager for the Philippines, VMware I look after the garden. I’d like to think that I have a green thumb—no plants have died so far! The ones I like now that I planted a few months ago is the Blue Iris. Like the town in the movie, my Blue Iris shows up in the morning and only appears for one day. …

  • JGFP Summer Tour on today

    The summer tour for local junior golfers kicks off with the holding of the ICTSI-JGFP Baguio Junior Open today and tomorrow at the treacherous Baguio Country Club course in Baguio.Sixty players aged 6 to 17 years old are entered in the 36-hole tourney serving as the opening leg of the summer circuit organized by the Junior Golf Foundation of the Philippines with the International Container Terminal Services, Inc. Foundation as main sponsor. ... …

  • PH now market ready to absorb infra bonds

    The Philippine market is now ready to absorb infrastructure bonds that will be issued by private companies amid a growing pipeline of infra-related projects under the government’s Public-Private Partnership (PPP) program. President Benigno Aquino III last week said the government is still committed to spend more on the country’s infrastructure, with 16 PPP projects currently on the pipeline and nine that have already been awarded. Over the years, some of the country’s biggest infrastructure …

POLL

Should Aquino be held accountable over the Mamasapano operations?

Loading...
Poll Choice Options