A high-stakes guessing game has broken out on Wall Street: what might investors have to sell if the US government loses its triple A credit rating for the first time?
Even with a tentative deal to raise the debt ceiling agreed late on Sunday, the Washington acrimony required to get there has left few analysts confident that US Congress can agree sufficient deficit reduction measures to placate Standard & Poor’s, the rating agency most negative in its outlook for US government finances.
S&P wants to see $4,000bn in cuts, far more than the proposals being discussed. But it is understood that the agency is unlikely to rush out with any statements if a deal is reached that delivers a deficit reduction well below this figure.
Estimates for asset sales range from virtually nothing to $300bn of Treasury selling that one very large sovereign wealth fund is using as its base assumption after conversations with its broker dealers. JPMorgan puts the upper bound of holdings at bond funds which might be forced sellers at $40bn, a small fraction of the $10,000bn market.
The broader effect, however, could be a rise in interest rates that pushes up the cost of all forms of debt, threatening the fragile global recovery.
Many eyes are fixed on money market funds, an important source of short-term funding for many businesses and financial institutions. It was a rush of withdrawals in 2008 that caused a breakdown in the commercial paper markets, deepening the financial crisis.
The funds would not have to sell Treasuries in the event of a downgrade, but could become forced sellers if they were hit by redemptions. Money market funds suffered their largest outflows since January this week as investors redeemed a net $32bn from the sector, according to data from Lipper, a research company.
Barclays Capital estimates that prime and government-only money market funds own $660bn of direct Treasury debt bonds issued by government-sponsored agencies like Fannie Mae and Freddie Mac, and also hold an additional $470bn in security repurchase, or “repo”, positions. That accounts for 47 per cent of money fund assets.
“At the moment, there is little question that news about the US credit rating is unnerving money fund investors fearful about protecting their principal,” said Joe Abate, strategist at Barclays.
Meanwhile asset managers maintain that a downgrade will not produce a wave of forced selling.
A survey of 29 investors by UBS found very few potential sellers of Treasuries. In the event of a downgrade, hedge funds were the only respondents who would sell and they were outnumbered by peers who would be buyers. Central banks and sovereign wealth funds would do nothing, the survey found.
“The Treasury market remains the primary beneficiary of global reserves amid a lack of alternatives,” said Ira Jersey, strategist at Credit Suisse. “A downgrade will convey no new fundamental information,” he added.
George Goncalves, head of interest rate strategy at Nomura Securities does not expect long-term investors will sell their holdings of US Treasuries.
The effects could be felt in sales of more risky assets, however. Separately managed accounts held at asset managers for central banks and some large sovereign wealth funds and businesses often have average credit quality criteria that are effectively double A.
“You could see people being forced to sell lower-rated corporates or high yield debt to get the average credit quality of that portfolio back to that double A standard”, said the head of one asset management business.
Yet a US downgrade is not a certainty and Moody’s and Fitch may not follow any S&P cut.
Last week, Fitch Ratings said: “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 US economy, Treasuries’ deep liquidity and fundamental role in the global financial architecture, and the lack of comparable, marketable alternatives.”
Moody’s, which last month initiated a review of the US sovereign rating said late on Friday that its “review for downgrade will more likely than not conclude with a confirmation of the Aaa rating, albeit with a shift to a negative outlook.”
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By Dan McCrum and Michael Mackenzie
Source: www.ft.com
Even with a tentative deal to raise the debt ceiling agreed late on Sunday, the Washington acrimony required to get there has left few analysts confident that US Congress can agree sufficient deficit reduction measures to placate Standard & Poor’s, the rating agency most negative in its outlook for US government finances.
S&P wants to see $4,000bn in cuts, far more than the proposals being discussed. But it is understood that the agency is unlikely to rush out with any statements if a deal is reached that delivers a deficit reduction well below this figure.
Estimates for asset sales range from virtually nothing to $300bn of Treasury selling that one very large sovereign wealth fund is using as its base assumption after conversations with its broker dealers. JPMorgan puts the upper bound of holdings at bond funds which might be forced sellers at $40bn, a small fraction of the $10,000bn market.
The broader effect, however, could be a rise in interest rates that pushes up the cost of all forms of debt, threatening the fragile global recovery.
Many eyes are fixed on money market funds, an important source of short-term funding for many businesses and financial institutions. It was a rush of withdrawals in 2008 that caused a breakdown in the commercial paper markets, deepening the financial crisis.
The funds would not have to sell Treasuries in the event of a downgrade, but could become forced sellers if they were hit by redemptions. Money market funds suffered their largest outflows since January this week as investors redeemed a net $32bn from the sector, according to data from Lipper, a research company.
Barclays Capital estimates that prime and government-only money market funds own $660bn of direct Treasury debt bonds issued by government-sponsored agencies like Fannie Mae and Freddie Mac, and also hold an additional $470bn in security repurchase, or “repo”, positions. That accounts for 47 per cent of money fund assets.
“At the moment, there is little question that news about the US credit rating is unnerving money fund investors fearful about protecting their principal,” said Joe Abate, strategist at Barclays.
Meanwhile asset managers maintain that a downgrade will not produce a wave of forced selling.
A survey of 29 investors by UBS found very few potential sellers of Treasuries. In the event of a downgrade, hedge funds were the only respondents who would sell and they were outnumbered by peers who would be buyers. Central banks and sovereign wealth funds would do nothing, the survey found.
“The Treasury market remains the primary beneficiary of global reserves amid a lack of alternatives,” said Ira Jersey, strategist at Credit Suisse. “A downgrade will convey no new fundamental information,” he added.
George Goncalves, head of interest rate strategy at Nomura Securities does not expect long-term investors will sell their holdings of US Treasuries.
The effects could be felt in sales of more risky assets, however. Separately managed accounts held at asset managers for central banks and some large sovereign wealth funds and businesses often have average credit quality criteria that are effectively double A.
“You could see people being forced to sell lower-rated corporates or high yield debt to get the average credit quality of that portfolio back to that double A standard”, said the head of one asset management business.
Yet a US downgrade is not a certainty and Moody’s and Fitch may not follow any S&P cut.
Last week, Fitch Ratings said: “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 US economy, Treasuries’ deep liquidity and fundamental role in the global financial architecture, and the lack of comparable, marketable alternatives.”
Moody’s, which last month initiated a review of the US sovereign rating said late on Friday that its “review for downgrade will more likely than not conclude with a confirmation of the Aaa rating, albeit with a shift to a negative outlook.”
Please respect FT.com's ts&cs and copyright policy which allow you to: share links; copy content for personal use; & redistribute limited extracts. Email ftsales.support@ft.com to buy additional rights or use this link to reference the article - http://www.ft.com/cms/s/0/85c8d804-b9f2-11e0-8171-00144feabdc0.html#ixzz1VapWqK8C
By Dan McCrum and Michael Mackenzie
Source: www.ft.com
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