Credit ratings agency, Standard & Poor’s, has downgraded the long-term credit rating of the US from AAA to AA+.
What does it all mean?
It is a history-making event, but the longer-term implications are limited. Of the three major credit rating agencies only Standard & Poor’s has seen fit to downgrade the credit rating of the US. Neither Moody’s nor Fitch Ratings has adjusted the long-term credit rating of the US.
The implications are limited. While it is a history-making event, at the end of the day the major investors are unlikely to abandon US treasuries or the US dollar. Simply, the alternatives aren’t compelling. Would China switch from the most liquid bond market in the world to European or Japanese bonds?
The US Federal Reserve has advised that there is no change to the capital requirements of banks. And there is only likely to be a limited number of investors that would need to cut investments in US treasuries as a result of the downgrade. Only one credit rating agency has changed the credit rating of the US, and only then, the long-term rating.
While there is the potential for volatility on Monday August 8, investors have had the weekend to work through the implications. The Saudi Arabian sharemarket traded both Saturday and Sunday. At time of writing, the Saudi Arabian sharemarket was down just 0.04 per cent on Sunday August 7. Other Middle Eastern markets were down between 0.3-4.2 per cent but all were catching up on the US and European sharemarket sell-offs on Thursday.
There are plenty of positives flowing from the decision. US and European politicians and policymakers have been given a clear message to get their fiscal houses in order. Standard & Poor’s has indicated that its decision was largely prompted by the political infighting to achieve the 11th hour decision on raising the US debt ceiling. Now the pressure is on politicians to negotiate a longer-lasting budget and debt solution or face the risk of another downgrade.
For Australian investors it is a case of staying focussed on the big picture. Australia is more dependent on China than the US or Europe – not only the trading relationship but also the broader economic relationship. The global economy is also driven now by emerging nations, especially Asia, and in particular, China.
For Australian corporate borrowers there is the risk that global lenders may increase the risk premium on all loans, bumping up credit spreads in response to the uncertainty prompted by the rating action. But this is expected to be a short-term knee-jerk action.
If the European and US debt crises were to create a second GFC, the Reserve Bank would swiftly cut interest rates, benefitting Australian small business and home borrowers. Oil prices have already fallen and could fall further, benefitting Australian motorists. The Australian government debt to GDP ratio is the lowest of any advanced nation, putting Australia in a strong position. If the Australian dollar was to soften on a movement away from “risky currencies” it would benefit exporters, tourism markets and manufacturers.
What are the implications for interest rates and investors?
The risk is that the Reserve Bank may need to cut rates if the US and European debt crises were to result in another GFC. The first crisis was actually – in Reserve Bank words – a Northern Hemisphere financial crisis. The second crisis would again be a Northern Hemisphere financial event – but this time affecting country debt, rather than banks or companies.
We believe that the S&P credit rating decision won’t have lasting implications for markets. It is a history-making event, but other countries – including Australia – have faced credit downgrades in the past without significant long-lasting implications on investment flows. The US is also is a special position, possessing the most liquid financial market in the world. Major creditors have few credible investment alternatives.
As the latest US employment figures show, the economy is far from on its knees, but it is up to the Federal Reserve and policymakers to ensure that momentum is reignited and maintained.
