Market madness: Don't blame Standard & Poor's for the madness of markets. The credit rating agency targeted US debt, but it was stocks not Treasuries that got clobbered on Monday. The counterintuitive reaction, however, is less bonkers than it seems.
The S&P 500 index tumbled more than six percent, with financial institutions getting hit the hardest. Bank of America lost over a fifth of its market value at one stage. It may not look rational, especially after corporate America spent the last three years repairing balance sheets and banks adding to their capital cushions.
The value of America's debt, meanwhile, soared. The 10-year Treasury yield fell to as low as 2.33 per cent, a whopping 0.23 percentage point less than the already low level on Friday. The security's status as a safe haven for panicky investors certainly helped the government debt market shake off the S&P downgrade. But, the magnitude of the rally combined with the bloodbath in stocks and other risky assets indicate something more at work. It could be the punch of the downgrade had less to do with the US creditworthiness and so much more with the reality check it provided investors about America and its economy.
Global stocks had already taken a beating before the downgrade. The troubled euro zone, weak US economic data and the debt ceiling fiasco unnerved those who believed the Federal Reserve's double-barreled monetary policy eradicated any chance of a double-dip recession. The US high-yield bond market now puts the chance at 30 per cent and climbing, according to Martin Fridson, a strategist for BNP Paribas.
Those odds are scary enough. More frightening, though, is the paucity of levers to pull to alter it. S&P's verdict is a stark reminder that Washington has become so dysfunctional that lawmakers couldn't devise a credible plan to solve the nation's longer-term deficit problems. That makes a short-term fiscal fix, like another stimulus plan, even more remote. Meanwhile, the Fed, which has already dabbled with experimental policy to limited success, doesn't have much more in its tool bag to get the economy back on track.
All of it bodes far worse for sentiment on both the Wall Street and Main Street than any single-letter grade change could possibly do.