S&P downgrade … various

These are some of the sources that I have turned to for a discussion of the S&P decision to downgrade the US. Some good info in here, some good opinion pieces too. Impossible to pick out a few quotes (but I’m going to anyway), best to read each of these and weigh up the arguments.

The Aleph Blog

My point is that the initial downgrades of a AAA entity come hard, but once they come, they come with vigor and speed. S&P has cleared the way for Moody’s and Fitch to downgrade as well. The cost for them to downgrade is a lot lower now, and they can go lower than Aa1/AA+ if they choose. Without significant change, the ratings of the US go lower from here.

Now as a bond manager, I tell you there should be little change from the change in ratings. Why?

The rating of the US is still AAA, which is the average of Aaa/AA+/AAA
Downgrades of bonds rarely result in price changes on average.
Whenever major sovereign downgrades occur, covenants, collateral haircuts, investment guidelines, risk-based capital charges, etc. all get changed to make sure that nothing happens as a result. Why? Ratings are an opinion, nothing more. No one wants actions to occur on a sovereign because of a downgrade.

There are a lot of naive people speaking and writing about the downgrade as if it means something big, and they have never managed bonds in their lives. I am not the be-all or end-all on this topic, but I would encourage people to read the opinions of those active in the bond markets before making definitive statements that have no reality behind them.

Aleph links to an article on Reuters with opinions from those actually managing bonds:
Instant view: U.S. loses AAA credit rating from S&P
I would only add that these traders, while speaking with some authority, are still traders and may well be subject to the various biases/emotions/pitfalls that tend to afflict many, many traders (but probably to a lesser degree).

A long piece from the Naked Capitalism blog: Will S&P Downgrade Be Another Y2K Scare?
Lots of good points in it, really worth a read. I am picking this out:

Treasury yields fell 50 basis points last week despite the risk of a downgrade being very well telegraphed. S&P had asked for $4 trillion in deficit reductions (it tried disavowing that number) and made it clear it was going off to brood and might take action. And this market response took place with S&P leaking like a sieve. Not only was Twitter alight early on Friday with rumors of the downgrade, but some parties purportedly got the memo earlier in the week. From a credible source via e-mail:

Good friend passed on a note from a hedge-funder who thinks the S&P not only fudged its figures for today’s downgrade, but leaked it in-advance earlier this week to a few hedge fund insiders who made a killing off it. That would square with the fake “states face bankruptcy” panic scam earlier this year, which made a few people a lot of fast money.

While Yves suggests that money was made by buying volatility I reckon its more likely the money was made shorting stocks and stock index futures, on the basis that equities and equity futures tend to be more skittish than the bond markets and there is a greater likelihood of a ‘chicken with its head cut off’ panic on the stock market than the bond market (not to mention an offsetting ‘flight to quality’ effect in the UST market …….. yes, despite a ratings cut, the market for US Treasuries is still the deepest and most liquid by far). This might be me coming up with an after-the-fact explanation for the extended fall in the equity markets we had last week, but it fits with my mental model of what it is that moves markets (in brief, and apart from exogenous events like earthquakes, and inter alia, if you want to ascertain the most likely direction of the markets, try to discover what it is the big money movers are focusing on and moving their money in response to).

From the Economist’s View blog: The S&P Downgrade: Is the Sky Falling?, focusing on the asymmetric risks faced by ratings agencies on the US sovereign ratings question.

From Kid Dynamite (& I should add you don’t get titles of posts much better than this one): “Irony is that the same people who rated a flaming bag of crap AAA have downgraded us.”
I think Kid Dynamite really nails this downgrade decision, and I’m sorry to have to quote nearly the entire post:

… there’s really only one important line in my opinion. Read this one carefully:

“The political brinksmanship of recent months highlights what we see as America’s governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy.”

And that is why I pulled the prior paragraph about our disfunctional partisan government. S&P has downgraded the United States Congress, in my opinion.

Felix’s next sentence summed it up, emphasis mine:

“Secondly, the US does not deserve a triple-A rating, and the reason has nothing whatsoever to do with its debt ratios. America’s ability to pay is neither here nor there: the problem is its willingness to pay. And there’s a serious constituency of powerful people in Congress who are perfectly willing and even eager to drive the US into default.”

Market direction from here?
Don’t know. I suspect a lot of the selling that needed to be done has been done and that any further extension of the losses from last week will be met with a lot more bids than were around last week. Could it go much lower? Yes, of course. Could it begin to form a base around these levels? Yes again. I’m not brave enough to make predictions here, and luckily I don’t have to.

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