–US Tsys Could Experience Near-Term Volatility In Event Of Downgrade
WASHINGTON (MNI) – The following are excerpts from a report
Wednesday by Fitch Ratings noting that in the event of a U.S. sovereign
downgrade by a major rating agency, U.S. Treasuries and broader
financial markets could experience near-term volatility. However, Fitch
expects that, over the near to medium term, in the event of a moderate
downgrade, U.S. government securities would likely retain their standing
as the benchmark security of the global fixed income market:
In the event of a U.S. sovereign downgrade by a major rating
agency, U.S. Treasuries and broader financial markets could experience
near-term volatility, according to Fitch Ratings. However, Fitch expects
that, over the near to medium term, in a moderate downgrade scenario
(e.g., to ‘AA’), U.S. Treasuries would likely retain their standing as
the benchmark security of the global fixed income market.
The possibility of a downgrade of the current ‘AAA’ U.S. sovereign
debt rating has triggered numerous warnings about the consequences of
such a move for global financial markets and the U.S. economy. Common
speculation is that a downgrade could cause a significant sell-off of
U.S. Treasuries, funding market dislocations, and longer-term structural
increases in U.S. borrowing costs.
Although a sovereign downgrade could spark near-term market
volatility, Fitch notes that credit risk, as reflected by the credit
rating, is only one of several drivers of pricing. In a moderate
downgrade scenario, Treasuries are expected to remain the benchmark
security that anchors global fixed income markets for the foreseeable
future. Their status as the global benchmark security is bolstered by
the underlying strength of the U.S. economy, Treasuries’ deep liquidity
and fundamental role in the global financial architecture, and the lack
of comparable, marketable alternatives.
—
The underlying financial position of the U.S., along with many
other sovereign borrowers, has deteriorated as a result of the financial
crisis and recession. However, the fundamental strength of the U.S.
economy and widespread perception of the U.S. sovereign as a
high-quality credit is likely to persist for the foreseeable future,
even in a moderate downgrade scenario.
The U.S. sovereign’s robust credit quality is one of many
attributes underpinning the predominance of U.S. Treasuries.
The exceptional size, dynamism, and diversity of its economy
enables the U.S. to issue debt securities on an unparalleled scale. The
stock of U.S. Treasuries far surpasses that of comparable, marketable
low-risk securities (see the Unrivaled Size of U.S. Treasury Markets
chart on page 1).
The $9.3 trillion in marketable U.S. Treasury securities is roughly
five times the size of French ($1.9 trillion), U.K. ($1.8 trillion), and
German ($1.6 trillion) government bond markets. Other European
alternatives, including German ($900 million) and Spanish ($500 million)
covered bonds and the recently formed European Financial Stability
Facility ($78 billion in guaranteed debt), remain small by comparison.
‘AAA’ rated corporates are assigned this high rating in part because
they issue relatively little long-term debt, as exemplified by
ExxonMobil Corporation ($12 billion).
Another related factor supporting the U.S. Treasury’s predominance
as a benchmark security is its unparalleled market liquidity. For
example, daily trading volumes of Treasuries ($580 billion) are almost
10 times higher than that of U.K. gilts ($34 billion) and German bunds
($28 billion) combined (see the chart below). This deep market liquidity
enables holders to convert Treasury securities into dollars with
negligible transaction costs, irrespective of market conditions.
Additionally, as evidenced repeatedly by the decline in Treasury
yields during the many episodes of turbulence in financial markets,
investors perceive U.S. Treasuries as a “flight to safety” when
uncertainty takes hold. The appeal of Treasuries also extends to
risk-averse investors with a longer view. A significant portion of
issuance outstanding is held by foreign official institutions, which
increased net holdings of Treasuries over the past year despite the
relative decline in the financial position of the U.S. (see the chart
above).
Since midyear 2010, total foreign official holdings of Treasuries
have increased by $170 billion and exceeded $3.2 trillion as of end-May
2011. Over the same period, total foreign Treasury holdings rose from
roughly $4 trillion to more than $4.5 trillion, with holders in China
and Japan increasing their positions by 4% and 14%, respectively.
Finally, Treasuries play a prominent role in the global financial
architecture. For example, approximately 80% of U.S. triparty repo
markets, which several major financial institutions use to finance their
securities inventories, are collateralized by either Treasuries or other
securities whose credit quality is closely tied to the U.S. sovereign
(e.g., mortgage-backed securities [MBS] guaranteed by Fannie Mae and
Freddie Mac and debt securities directly issued by government-sponsored
enterprises [GSE]) (see the table above). The stature of Treasuries is
bolstered by the U.S. dollar’s role as a global reserve currency and its
widespread use in commodities pricing, international trade, and
financial transactions.
** Market News International Washington Bureau: 202-371-2121 **
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