08/08/2011
By Matt Ritchie
Last week’s decision by Standard & Poor’s (S&P) to downgrade the United States’ long-term sovereign credit rating from AAA to AA+ ended a harrowing week for Wall Street, and its impact has been felt today throughout global markets.
Late on Friday, the ratings agency cited “prolonged controversy” over raising the US’ statutory debt ceiling and the related fiscal policy debate as indicators that slowing growth in public spending, and reaching agreement on raising revenues, is less likely than previously assumed.
“We also believe that the fiscal consolidation plan that congress and the administration agreed to this week falls short of the amount that we believe is necessary to stabilise the
general government debt burden by the middle of the decade,” the agency said.
Reuters reported that the Nasdaq fell sharply upon the markets opening, with sectors most sensitive to the economy hit particularly hard.
Meanwhile, Bloomberg reported that option prices across Europe and Asia jumped, while stock values tumbled.
The US disputed the downgrade decision, with acting assistant secretary for economic policy John Bellows issuing a blog post on the Treasury website pointing out what he called a “basic math error” of US $2 trillion in S&P’s calculations.
While S&P acknowledged the error, it has stood by its decision. Fitch Ratings and Moody’s have both maintained their AAA ratings for the US.
Head of fixed income and currency at Barings Asset Management Alan Wilde said Barings has long held the view that the US’ credit rating was unsustainable, and S&P’s move was unlikely to come as a surprise to other market participants.
Wilde said the Federal Reserve has confirmed that it will continue to accept Treasuries as collateral, and that financial institutions will suffer no capital penalty for holding US government debt.
“However, it remains to be seen whether other central banks and regulators will follow suit.”
Wilde said the response of foreign public-sector money to the downgrade is “probably the most crucial” unknown factor for financial markets and the path of the global economy.
Fund manager Fidelity said confidence is likely to be hit by the downgrade, and the full effect of the move on the global economy and equities remains to be seen.
Chief investment officer of equities at Fidelity Dominic Rossi highlighted the S&P’s reference to the recent political wrangling over raising the debt ceiling, and said the downgrade would likely have significant implications for next year’s presidential election.
Rossi said the downgrade will hasten the debasement of the US dollar, while commodity price increases are already having an impact on the general price level of the greenback, eroding real incomes and living standards.
“My overall view is that the decision is of huge significance. It is humiliating for the government and it is an indictment of the federal system. It also undermines the world reserve currency, and raises the prospect of stagflation. Good can come from the S&P downgrade, if this humiliation stirs Washington into action. The risk is they will focus on the AAA ratings from the other agencies, and bad mouth S&P instead.”
Despite the downgrade, Fidelity said large holders of US debt have “little incentive” to sell, and US banks, money market funds and insurance firms have to hold US debt to meet capital requirements and maintain liquidity.
Further, the fund manager pointed out the fact central banks the world over will continue to use the dollar as reserve currency.
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