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 39.

    Look at it this way:


    America wouldn't be America if it didn't do this sort of thing.
    Like having gas guzzling cars - and dare I say it - guns.

    Call it brash full, call it stupidity, it's American.

    It,s why Bush landed on an aircraft carrier and declared the Iraq for won.

    Meanwhile this trait is exploited by the 4th estate.
    And looked upon incredulously by foreigners.
    To get an edge.

  • rate this

    Comment number 38.

    This brinksmanship is bad for everyone. Some people have commented that the Republicans are tampering with a democratic decision and while this is true up to a point, they are elected too and with they have a mandate to approve budgets. They are withholding this approval as they are rightly concerned about the federal deficit and accumulated debt. There is fault on both sides.

  • rate this

    Comment number 37.

    I don't see that the price and yield of US or UK government bonds is (usually, at least) anything to do with the chance of them not being repaid, because that has virtually never happened. And if it did, the whole house of cards would collapse, whatever the term date.
    Surely the price has more to do with the perceived value of the yield versus other available assets? And expectations of this?

  • rate this

    Comment number 36.

    Only true egotists would play out their own stupidity out on a world stage

  • rate this

    Comment number 35.

    If the solution involved Cruise Missiles and then sending in the Marines then we would have a solution before lunch !

  • rate this

    Comment number 34.

    America the world is losing patience with you.

  • rate this

    Comment number 33.

    I bet somewhere in North Korea, someone is thinking "now why didn't WE think of that?" The Tea party, dong the work of the worlds Axis of Evil on their own home turf.

  • rate this

    Comment number 32.

    "The fools in Congress still think they have the cash to wage worldwide wars - THEY HAVEN'T"
    Wars are a scam to cream money from tax payers
    $39,5 billion went to Cheney's Halliburton
    several billion went on walk-about

    Black Ops is a licence to scam make money guns drugs juggling to fund double secret covert black missions of illegal warmongering kind. Did US gamble go long banking on Syria war

  • rate this

    Comment number 31.

    "One of the interesting consequences of this debacle is that it shines a light on the eye watering public debt in the USA and of course elsewhere"
    It will be auditors job to identify how it happened (or look the other way if price is right)

    US has high income
    US invests worldwide
    US can move funds make books show no profits all debts

    debt default can force bankruptcy seize property assets

  • rate this

    Comment number 30.

    The republicans are going to lose so badly at the next election...

  • rate this

    Comment number 29.

    One of the interesting consequences of this debacle is that it shines a light on the eye watering public debt in the USA and of course elsewhere..
    If it is necessary to borrow just in order to pay the interest then it is obvious that if interest rates were forced up then the USA would experience a debt trap.
    These huge debts in the West mean countries are floating on a sea of falling confidence..

  • rate this

    Comment number 28.

    I can't believe the US government (and the Republicans in particular) are willing to risk the entire global economy again(!) over a domestic issue like healthcare reforms. Oh wait - it's the Republicans - I CAN believe it.

  • rate this

    Comment number 27.

    'self-inflicted wounds'
    how true
    but also displaying a level of introspection bordering on insanity.
    poorer countries are suffering while the US selfharms

  • rate this

    Comment number 26.

    Perhaps it's time the Democrats and Republican parties swapped emblems. In WW1 German General Ludendorff is reputed to have said "The British troops fight like lions". General Hoffman replied "Yes, but they are lions led by donkeys". So the donkey would be more apt for the Republicans.

  • rate this

    Comment number 25.

    There will not be default a fudge will be found.

    Problems for financial markets come when the unexpected happens. That is not the case here.

  • rate this

    Comment number 24.

    The Republicans are cutting off their own nose to spite their own face.
    The US Dollar is at present the reserve currency and oil is brought and sold with it. A loss of confidence in it could see the Chinese Yuan take its place which would then really put the screws on the Americans.

    And what is this all for? Denial of proper medical care which the Americans voted for.

    You could not make it up!

  • rate this

    Comment number 23.

    If someone was to hire a Washington DC taxi cab at $2.16 per mile with the $16.75 trillion US national debt in their pocket, they would end up over 1.3 light years away.

    Maybe some of those on Capitol Hill should take a ride (or maybe they already did...)

  • rate this

    Comment number 22.

    The US Federal Government is bankrupt, is all - America per se, is rich
    beyond compare, plus we have trillions of bucks, in Cash in America &
    EU/UK where Uncle Sam cannot access it - now might be a good time
    to close down the Feds & reboot America, which is what Obama should
    have done in the first place instead of wasting another $14T with nothing
    to show for it - impeach 535 idiots + 1 CiC now

  • rate this

    Comment number 21.

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

    Linda,one thing we all have learned is that if its bad for Banks and Markets they will rapidly pass on the pain to the tax payers.

    If its good for them we will never see the gains.

    The whole system is bust......

  • rate this

    Comment number 20.

    The question must be asked why the credit agencies still rate the U.S. as AAA when they owe $2,348 for every man, woman, and child on the planet, with no hope whatsoever of ever paying it back. Just the interest payments alone would be enough to beggar any other nation even without reducing the actual sum owed.


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