Invariably, it is the market that determines the value of a security, not a rating agency.
That was made clear today as Treasury bond prices soared and yields plummeted in the wake of the S&P downgrade of U.S. debt. As of this writing, the 30-year Treasury yield is below 3.70%, while the 10-year bond is yielding approximately 2.35%.
Although there are clearly financial challenges ahead for the United States, this counter intuitive market action clearly illustrates the adage, “In the land of the blind, the one-eyed man is king.”
U.S. bond market remains the world leader
The U.S. Treasury bond market is still the largest, most liquid market in the world and represents the ultimate in quality, regardless of any proclamation from a rating agency. We should keep in mind that this is the same rating service that told us the securitized subprime mortgage bonds that led to the financial crises in 2008 were gilt-edged “AAA” securities.
The security of Treasury bonds is exactly the same as it was a day before the downgrade and the same will be true of municipal bonds that find their ratings downgraded on a relative basis as a result of this symbolic action on the part of S&P.
Safer havens?
According to S&P, France, Lichtenstein, and New Zealand are safer havens for investment dollars than the U.S. Obviously, no one else believes this to be true.
Abraham Lincoln would often engage his audience to make a point. He would ask “How many legs does a dog have if you call the tail a leg?” The correct answer was four. He would say, “Calling a tail a leg doesn’t make it a leg.”
As the world markets demonstrate, calling the USA “AA+” doesn’t make it so.
Notwithstanding the credibility, or lack thereof, of S&P, we are hopeful that this will result in a wakeup call for the U.S. government.
Having witnessed the recent “dance of the buffoons” in Washington during the debt ceiling negotiations, it is difficult to imagine that the administration or Congress has the resolve to focus on any issue other than their own re-election.
We can hope, however, the S&P action may serve to embolden the congressmen, senators and electorate who recognize that spending cuts and entitlement restructuring, as well as tax reform, are critical to restoring the United States to fiscal sanity.
Although a positive development, U.S. and global deleveraging will have a longer- term effect of dampening economic growth and, in turn, keeping interest rates low for a considerable period of time.
All the pundits who for years have encouraged investors to buy short-term bonds and employ short-term laddering strategies will continue to fail their constituents.
At the same time, high quality, long-term municipal bonds providing tax-free yields of 5.00% or more will one day be looked upon with nostalgia, as they continue to reward tax-free bond buyers just as they have in the past.
