The sound and the fury in US debates

A sign saying AAA

As I'm writing this, the headlines are wavering between optimism and pessimism over a deal on the US debt ceiling with Thursday's purported deadline looming.

The alternative is hard to contemplate and the hope is that the US will pull back from the brink once again.

But, even if the US comes to another last minute agreement, damage has been inflicted as Fitch has downgraded the US outlook to negative which could lead the world's largest economy to lose its AAA rating once again.

Fitch assigned the negative outlook over the "repeated brinksmanship" over the debt ceiling, which opens the door to the US losing its top credit rating from two of the three major ratings companies.

Even if they agree to resolve it, Fitch says that "subsequent review of the ratings would take into account the manner and duration of the agreement and the perceived risk of a similar episode occurring in the future".

Almost the same scenario happened in 2011 when S&P downgraded the US in a historic moment. The agreement struck then raised the debt ceiling for two years to get through the presidential election. But, here we are again.

Looking back, the impact of the US losing its AAA rating was rather muted. In August 2011, the benchmark cost of borrowing for the US was roughly what it is now. The yield or interest rate paid on 10 year government bonds was 2.6%. Now, it's about 2.7%.

And US Treasuries remain the benchmark for debt of the highest quality.

Growing uncertainty

Still, there's more nervousness this time as it's happened again.

We saw this briefly in 2011, but the rise in short-term borrowing costs is much more pronounced this time. There's an "inversion" of the very short end of the US bond yield curve.

Normally, it costs more for a government to borrow over the longer-term because the chances of it not being repaid in the future are higher. A normal yield curve sees lower cost of borrowing for one month, three months, one year than for 10 and 30 years.

When a yield curve inverts, it means that short-term borrowing costs rise and are higher than longer-term ones.

There are two interpretations for an inverted yield curve. One is recession as investors expect interest rates to be cut in order to support the economy.

The second is default. Normally when a government defaults, short-term creditors lose out because they are often the ones that are not paid or are subject to debt restructuring and receive less than what they lent.

Since the debt ceiling wrangling, the US Treasury yield curve has inverted at the very short end. It now costs twice as much to borrow for one month than three months. The one month yield has jumped to 0.32% from 0.01% a month ago.

You would be right in thinking that the debt ceiling was officially hit in May so it's been going on for longer than that. That is indeed true, but it took the US Treasury Secretary Jack Lew saying on 25 September that the money will run out to pay bills on 17 October for it to fully register.

Minimal impact?

This is still a fairly small phenomenon and likely only of significance to banks and the markets at this stage.

But, it points to concerns over the US not getting its act together and what investors do could eventually affect us and our borrowing costs, which I have written about before.

As for the US potentially losing the top credit rating from two of the three ratings agencies, there would normally be concern that a country or a company that has a majority of non-AAA ratings could lose out because investors that have remits to invest only in AAA-rated debt would pull out.

Looking at Britain though, there hasn't been much of an effect. When the UK lost its AAA rating from Moody's, the loss was also historic. But, the second downgrade by Fitch didn't have a massive impact.

It's probably because rating companies' reputations have taken a beating since the financial crisis. I hear from investors that they feel fairly well-positioned to assess a country's economic potential and have begun to rely less on those agencies after the crash.

Also, the US, and to a lesser extent the UK, have central banks which have been buying government debt as part of their QE or quantitative easing programmes.

It's also likely due to the shrinking pool of AAA-rated countries to invest in. Recall that before the financial crisis, Spain and Ireland (both now receiving aid from the euro zone) were rated AAA.

At present, there are fewer than a dozen nations which are AAA rated across the board: Australia, Canada, Denmark, Finland, Germany, Luxembourg, Netherlands, Norway, Singapore, Sweden, and Switzerland. Some of those have negative outlooks attached as well, which means that the list could shrink even more within the next 2 years.

It normally takes more than a decade to restore a top AAA rating. And, it may not matter as much anymore.

But, the repeated brinksmanship over the debt ceiling is self-inflicted, and it brings to mind some aspects of American author William Faulkner's tale of financial ruin. The point about self-inflicted economic wounds, though, is that the US can do something about it.

Linda Yueh Article written by Linda Yueh Linda Yueh Chief business correspondent

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  • rate this

    Comment number 19.

    Why there is a debt ceiling? A sovereign currency is not like a household - this is the Euro-error. Money is destroyed by waste, disaster, wear and tear etc and replaced by the Fed. Some of the US debt was nationalised in 2008, as in the UK. Debt as a spending discipline is crazy - it is the efficiency and type of govt spending that matters. Good debt will repay by increased economic activity.

  • rate this

    Comment number 18.

    Credit ratings now following not leading the market so irrelevant. But the US debt crisis, together with QE, is eroding US$ status as global reserve currency. This may not be the trigger but implosion of the US$ is coming. Why do you think the City of London Sharks are so interested in the Remnimbi?

  • rate this

    Comment number 17.

    The USA bail outs has removed ALL value from the USA's economy (do the sums properly it could even be -ve in total)

    The fools in Congress still think they have the cash to wage worldwide wars - THEY HAVEN'T.

    They must look after their own poor and cut back on support for the fat cats of Wall Street (as they should have done in 2008).

    Result the inevitable unavoidable crash - it must happen!

  • rate this

    Comment number 16.

    "It normally takes more than a decade to restore a top AAA rating. And, it may not matter as much anymore."

    Who cares what the rating agencies think, these are not fit for purpose with another conflict of interest situation, which seems par for the course in today's business. Remember they gave AAA status to toxic sub prime mortgage debt 5 years back.

  • rate this

    Comment number 15.

    American Global Corps have moved US and Foreign money offshore without paying Tax. Richest 1% GOP have moved money offshore too.

    US Scam is to do business abroad and not pay tax there

    US Scam is move funds offshore and declare Bankruptcy

    US Scam is to force world into financial crises again

    Same scam as performed before with added greed aiming for bigger robbery this time

  • rate this

    Comment number 14.

    Short term US debt yields have risen as demand falls. To some extent the demand has switched to Sterling, driving one-month yields down to zero. In the event of a "technical" default, where there is every expectation that the US will pay up in full eventually, the "calamity" for the rest of the world could be limited if other currencies can take up the slack (Euro yields are already nearly zero).

  • rate this

    Comment number 13.

    Are USA stupid creating own downfall, or fraudulently dumping debt obligations after shiftily juggling assets into liabilities, moving funds away. Devil is in detail with secret black ops doing classified dirty deeds could well be trickery. Forensic analysis of USA will need to go back 13 years complex trades.
    911 had $280 billion covert funds issue not investigated

  • rate this

    Comment number 12.

    It will all come crashing down, its such a shame as well, but even if they pass it the market reaction of having to sit through all this again will be negative, No one will ever trust they can sort this out, if they keep pushing it back. They may raise their debt ceiling, but that does not mean anyone thinks there credit worthy, there just avoiding there problems imo.

  • rate this

    Comment number 11.

    2008 Financial Crises was due USA bundling up Toxic Subprime Loans

    Scam was distressed Mortgages & Loans were bought and sold on Markets as mutton dressed as Lamb given top notch AAA ratings prior to being downgraded

    Courts repossessed homes as Debt Buying firms without original loan notes targeted distressed homeowners refusing negotiations for settlement

    Same scam all over who owns US loans?

  • rate this

    Comment number 10.

    It's doing the Yanks no favours. The impression is being given of a divided society, an unfit for purpose political system and a country held to ransom by Tea Party lunatics.

  • rate this

    Comment number 9.

    The Tea Party have driven the GOP off a cliff, I hope enough Republicans remember that they're not all lunatics in time to pass some kind of resolution.

    As for Obama, his continued hardline approach to all Republicans is not helping. A better President would have avoided this situation.

  • rate this

    Comment number 8.

    Never, ever thought would write this, but the Chinese are right: time to de-Americanise the world.

  • rate this

    Comment number 7.

    It bears repeating that the proposed "solutions" to the current government shutdown and borrowing limit, aka debt ceiling, insure a repeat of this very same drama in two to four months. While most rational players expect the immediate crisis to be avoided, playing Russian roulette repeatedly is fatal. Those who assume the gun can only fire blanks wear ignorance like a badge of courage.

  • rate this

    Comment number 6.

    All because the Republicans don't like the Medicare proposals and want to protect the inefficient US private healthcare industry which consumes almost 20% of GDP and is one of the worst in terms of health care delivery in the developed world.

  • rate this

    Comment number 5.

    Extremist rants, Shutting down government to get their own way, forcing the government to agree to extreme measures in order to avoid national collapse. Sounds like Americas politics has reached the end of it's superpower life. Like Rome, Byzantium and Britain before it It must now redefine and restructure itself to adapt and like all three before it'll probebly need to self destruct to do it.

  • rate this

    Comment number 4.

    Personally I'm begining to wonder how many more times the US government can behave this badly before their whole system starts to collapse.

  • rate this

    Comment number 3.

    The experts at the United States and overseas are behaving like Chicken Little when it comes to the possiblility of an American default. That is poppy cock nonsense!! Many big multinationals and corrupt creditors like Communist China hates to see the punch bowl taken away from them. They love the Quantitative Easing policies of the Federal Reserve. They really do not care about Main Street USA.

  • rate this

    Comment number 2.

    The U.S. Political System, is doing more to threaten the U.S global position than Iran, Iraq, and Al Quieda, put together.

    For YOUR OWN SAKE sort it out.

  • rate this

    Comment number 1.

    In future years historians may link this borderline farcical display from the States, where they have such open disregard for broader global consequences together with the failed attempt at military intervention in Syria.
    Perhaps those future historians will mark this year as the point when confidence in American leadership was lost, the tipping point after which we accelerate to a new world order


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