US: Moody's threatens downgrade

US faces rating cut without budget deal: Moody's

Moody's Investors Service said it may join Standard & Poor's in downgrading the US's credit rating unless Congress next year reduces the per centage of debt- to-gross-domestic-product during budget negotiations.

SMH,

12 September, 2012

The US economy will probably tip into recession next year if lawmakers and President Barack Obama can't break an impasse over the federal budget and if George W. Bush-era tax cuts expire in what's become known as the “fiscal cliff,” according to a report by the nonpartisan Congressional Budget Office published on Aug. 22. The rating would likely be cut to Aa1 from Aaa if an agreement on the debt ratio isn't reached, Moody's said in a statement today.

Moody's put the rating under review with a negative outlook in August 2011, when the US pushed back a decision on spending and raised its so-called the debt ceiling after months of political wrangling. S&P cut its rating to AA+ that month, blaming the nation's political process. Treasuries rallied as investors ignored the reduction, with the yield on the benchmark 10-year note since declining to record lows and drawing the ire of investors such as Warren Buffett, the biggest shareholder of Moody's, who said after the S&P decision that the US should be “quadruple-A.”

“At some point, we might see the market demand a higher yield premium to own Treasuries, but I don't think that's the case now as this is just a shot across the bow,” said Jack McIntyre, a money manager in Philadelphia at Brandywine Global Investment, which oversees $US30 billion of debt. “It's hard to find a bond market that has the depth of liquidity that Treasuries do.”

Deficit Watch

McIntyre said his firm has reduced its Treasury holdings to lock in recent gains. US government debt has returned 6.4 per cent since the S&P downgrade and gained 9.8 per cent in 2011, the most since 2008, according to Bank of America Merrill Lynch index data.

Hours after the Moody's statement, the US's $US32 billion of three-year notes auction drew record demand.

The offering's bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 3.94, the highest on record, versus an average of 3.51 for the past 10 sales. The yield was 0.337 per cent, approaching the record low sale yield of 0.334 per cent set in September 2011.

“People are not worried about or focused on the Moody's report,” said David Brown, a money manager who helps oversee $US89 billion of fixed-income assets at Neuberger Berman in Chicago, said in a telephone interview. “The US has time and the means to deal with it.”

Debt-to-GDP

The Obama administration's February budget that was updated in August would result in a debt-to-GDP ratio of 75 per cent in 2022, New York-based Moody's said. While the S&P rating cut was based in part of the firm's view of the US political process, Moody's said it is waiting to see what policies are formulated.

“We will wait and see what they do in 2013, whether or not they come up with a specific proposal,” Steven Hess, senior vice president at Moody's in New York, said today in a telephone interview. “If there is no result and they delay doing anything serious on deficit reduction, it's likely that in 2013 we would move the rating down.”

Fiscal Cliff

The budget deficit will reach $US1.1 trillion this year, according to the CBO. That would be down from last year's $US1.3 trillion, in part because tax revenue has risen by almost 6 per cent and spending is down by about 1 per cent this year.

“Everybody knows that if we don't get our house in order, we're in trouble,” said Thomas Roth, senior Treasury trader in New York at Mitsubishi UFJ Securities USA Inc. “If you get downgraded twice, you're certainly not going to lend to that government at a lower rate.”

The US's Aaa rating with negative outlook would only be extended beyond 2013 if a “'fiscal cliff' actually materialized,” Moody's said today in the statement. “Moody's would then need evidence that the economy could rebound from the shock before it would consider returning to a stable outlook.”

House Speaker John Boehner said today that the Democratic- led Senate and a lack of leadership by Obama were to blame for inaction on legislation. “I'm not confident at all” that lawmakers will find an alternative to the spending cuts to meet the deficit target and avoid the expiration of the tax cut after the Nov. 6 election, the Ohio Republican said in Washington.

Coin Flip

For investors and policy makers, predicting the consequences of a rating change by S&P or Moody's -- the dominant issuers of debt scores -- may be little different from flipping a coin.

Almost half the time, government bond yields fall when a rating action suggests they should climb, or they increase even as a change signals a decline, according to data compiled in June by Bloomberg on 314 upgrades, downgrades and outlook changes going back as far as 38 years. The rates moved in the opposite direction 47 per cent of the time for Moody's and for S&P. The data measured yields after a month relative to US Treasury debt, the global benchmark.

Ratings companies are no longer trusted by the world's biggest investors, according to the former head of structured finance at S&P.

“They're there because people have to have them, not because people believe in them,” David Jacob, who was fired from S&P in December, said in July in an interview at Bloomberg headquarters in New York. “Maybe retail investors do, that's the unfortunate part, but I think institutional investors don't.”

Yields Increase

Buffett didn't immediately respond to an e-mailed request for comment sent to an assistant, Carrie Sova.

The 10-year yield rose three basis points, or 0.03 per centage point, to 1.69 per cent at 2:23 p.m. in New York, according to Bloomberg Bond Trader prices. The price of the 1.625 per cent note due in August 2022 fell 9/32, or $US2.81 per $US1,000 face amount, to 99 13/32. The yield fell to a record low of 1.379 per cent on July 25.

“Serious investors won't take the Moody's news with any kind of importance,” Adrian Miller, a fixed-income strategist at GMP Securities LLC in New York, said in a telephone interview. “The concerns of the fiscal cliff and its impact on the credit profile of the country are fully understood. As we get closer to the fiscal cliff, maybe. But there are more important things on our plate.”

The US dollar declined to its lowest level in almost four months versus the euro, weakening 0.8 per cent to $US1.2864. The dollar has rallied 11 per cent against the euro since the S&P downgrade in August 2011.