Standard & Poor’s reduction of the US credit rating may make it harder for other top-rated countries to keep their AAA ranking, according to Mohamed A El- Erian of Pacific Investment Management Co.
The downgrade by S&P “may well raise questions about other members of the dwindling AAA club,” El-Erian, 52, the Newport Beach, California-based chief executive officer and co-chief investment officer at Pimco, the world’s largest manager of bond funds, wrote in an email today. S&P gives 18 sovereign entities its top ranking, including Australia, Hong Kong and the Isle of Man, according to a July report.
S&P lowered the US one level to AA+ while keeping the outlook at “negative” as it becomes less confident Congress will end Bush-era tax cuts or tackle entitlements. The rating may be cut to AA within two years if spending reductions are smaller than the ones agreed to, interest rates rise or “new fiscal pressures” result in higher general government debt, the New York-based firm said yesterday.
Moody’s Investors Service and Fitch Ratings affirmed their AAA credit ratings on August 2, the day President Barack Obama signed a bill that ended the debt-ceiling impasse that pushed the treasury to the edge of default. Moody’s and Fitch also said that downgrades were possible if lawmakers fail to enact debt reduction measures and the economy weakens.
The UK, which is estimated to have debt to GDP this year of 80 per cent, six percentage points higher than the US, also has the top credit grade. In contrast with the US, its net public debt is forecast to decline either before or by 2015, S&P said in the statement yesterday.
NEW ZEALAND
New Zealand is the only country other than the US that has a AA+ rating from S&P and an Aaa grade from Moody’s. Belgium has an equivalent AA+ grade from S&P, Moody’s and Fitch.
“Investors should be cautiously positioned as the global economy and markets face major uncertainties,” El-Erian wrote. “The downgrade will be a further headwind to growth and job creation in the US”.
About $1.87 trillion has been erased from the value of US equities since July 22, including the 4.8 per cent plunge by the S&P 500 on August 4 that was the biggest drop since February 2009. US stocks fell the most in 32 months this week, erasing the S&P 500’s 2011 advance, as investors fled equities amid signs that the economy is stalling. Treasuries rose this week, pushing the two-year note yield to a record low.
‘UNTHINKABLE’
“The once-unthinkable loss of the AAA rating will constitute a further hit to already fragile business and consumer confidence,” El-Erian wrote.
The Thomson Reuters/University of Michigan final index of consumer sentiment fell in July to the weakest since March 2009. Gross domestic product climbed at a 1.3 per cent annual rate in the second quarter following a 0.4 per cent gain in the prior quarter that was less than earlier estimated, commerce department figures showed July 29. Still, American employers added more jobs than forecast in July and the unemployment rate fell for the first time in four months, the labour department said yesterday.
El-Erian also said that Americans will face “higher credit costs” over time. JPMorgan Chase & Co estimated that a downgrade would raise the nation’s borrowing costs by $100 billion a year. A US credit-rating cut would likely increase treasury yields by 60 basis points to 70 basis points over the “medium term,” JPMorgan’s Terry Belton said on a July 26 conference call hosted by the Securities Industry and Financial Markets Association.
The S&P 500 climbed as much as 1.5 per cent in the first five minutes of trading yesterday before turning lower as speculation swirled through the market that S&P was preparing to strip the US of its AAA rating. The index closed 0.1 per cent lower at 1,199.38.
Pimco’s $245.5-billion Total Return Fund, managed by Bill Gross, has returned 4.15 per cent this year, beating 40 per cent of its peers, according to Bloomberg data. Gross boosted his Total Return Fund’s investment in US government securities to eight per cent of assets in June from five per cent in May, according to Pimco’s website last month. Bonds in developed markets outside the US rose to 13 per cent of holdings from 10 per cent. Cash and equivalents dropped to 29 per cent from 35 per cent.
