US Treasury Downgrade – What Does This Mean To You?

A bond trader looks on as Treasuries rally.

This weekend the US Treasury was downgraded by Standard & Poors from its AAA credit rating to AA Plus.  This is an historic event for our country, and not in a good way.  It signals a very real black eye on the financial strength of our system.  This downgrade is now being followed by a string of similar downgrades on other government issued financial instruments, basically anything that has exposure to or is tied to the Treasury.

What is surprising about this rating downgrade is that money is now flowing out of stocks (just like all last week) and going into Treasuries.  You would expect people to be selling the Treasury on this downgrade news, but instead they are buying it.  So there is obviously still a great level of confidence in our Treasury bonds, much more so than our stock market at this point.

What could possibly happen in the future is that mutual funds and other institutional money funds who have rules about only owning AAA paper could be forced to sell the Treasury bonds and other US Govt agency paper.  We could also see selling of our Treasuries by foreign countries that are big holders of our bonds like China and Japan.  But this is yet to be seen.  For now, safe money is flowing into the Treasuries and that is a positive thing.  I think this signals an important fact about the role that the US plays in the global financial system.  No other country is able or willing to be at the center of the global financial system.  As bad as it is here right now, there really is no other better alternative place to park safe dollars.

Here are a few quotes from some of my favorite investment professionals about this downgrade:

“The U.S., which was cut Aug. 5 to AA+ from AAA at S&P, merits a “quadruple A” rating.  Financial markets create their own dynamics, but I don’t think we’re facing a double dip recession,” – Warren Buffett, age 80, yesterday in an interview with Betty Liu at Bloomberg Television.

“The future role of rating agencies will also now come under close scrutiny, bringing to the fore the question of who rates the rating agencies?  S&P’s action will likely unite governments in America and Europe in an effort to erode their monopoly power and operational influence.  This will also force all investors to do something that they should have been doing for years: conduct their own ratings due diligence, rather than rely on outsiders.”  – Mohamed A. El-Erian, CEO and co-CIO of PIMCO.

Only time will tell how this will impact the credit markets.  It could eventually lead to higher interest rates for everyone on things like mortgage rates, credit cards, and car loans, but for now that is not happening.  Money is flowing out of stocks and into bonds.  Washington is pointing the finger at Standard & Poors and the Tea Party for this whole problem.  Standard & Poors is blaming an inept Congress for the problem.  Pointing fingers is not going to solve anything.  Especially while Congress is on vacation.

 

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