On Friday, credit rating agency Standard & Poor’s cut the once-untouchable U.S. credit rating from AAA to AA+. The historic move shook global markets and created worries that the world’s largest economy is sliding quickly toward an unalterable recession. The agency based their decision on several factors, including the controversy surrounding the recently passed debt limit deal (which itself tarnished the reputation of U.S. fiscal policy), and the instability of underlying public finances.
S&P’s David Beers tried to downplay the severity of the downgrade, calling it: “a very small diminution, if you like, in the credit standing of the United States.” He added that it “is not a catastrophic decline in the U.S.’s [SIC] credit-worthiness.” The U.S. can always regain its top rating with S&P, “if we see that the climate in Washington becomes easier for the parties to come together on…fiscal policy,” and “a more robust and bigger fiscal stabilization program emerges in the future.”
Actions speak louder than words, and despite Beers’ message to “buck up,” the unprecedented downgrade preceded one of the worst days ever on Wall Street, as the Dow Jones industrial average plummeted more than 600 points on Monday. Even President Obama’s pledge to refortify government commitment to major debt reduction plans did nothing to console the markets.
Many hold S&P’s decision directly responsible for the most recent blow to the economy. But don’t shoot the messenger—S&P’s is just the bearer of bad news. Robert Wiedemer, author of Aftershock and a portfolio manager, says: “the downgrade isn’t the damage. It is simply moving into daylight the financial damage we have done that we have tried so hard not to see.”
The downgrade is merely a reflection of the current economic and political climate, deriving from “the current level of debt, the trajectory of debt as a share of the economy, and the lack of apparent willingness of elected officials as a group to deal with the U.S. medium-term fiscal outlook,” the agency stated. So why did the news of a downgrade send the Dow plummeting?
Investors are concerned about the slowing U.S. economy and European debt problems, and have become far more risk-averse in the midst of growing instability—both locally and globally.
“What’s rocking the market is a growth scare,” says Kathleen Gaffney, co-manager of the $20 billion Loomis Sayles bond fund. “The market is under a lot of stress that really has little to do with the downgrade.” Rather, Gaffney stated, investors are concerned with “how Europe and the U.S. are going to work their way out of a high debt burden,” especially with such slow economic growth.
Money flowed out of stocks and into treasuries as investors scrambled to reallocate their money to safer bets. It may seem ironic that the majorities have settled on the U.S. government debt—the very target of the recent downgrade. The massive shift sent the price of treasuries soaring. Yields, with an inverse relationship to the treasury price, fell substantially, reaching a new annual low of 2.34%.
The shakeup filtered through every aspect of a portfolio, from hard assets to commodities. Gold set a new record, rising $61.40 to settle at $1,713.20. The forecast is not as bright for the American dollar, as many predict weakness over the long term. Commodities such as crude oil and natural gas also fell sharply, amidst worries that a weaker and slower global economy will mean less demand.
S&P’s decision was like pouring salt into an already wounded economy, but it can hardly be held responsible for what has recently transpired. A harbinger of economic and political downfall, the downgrade actually was more of a wake-up call. No longer will bi-partisan gridlock and political brinksmanship be tolerated. The economy is paying for government shortcomings, trapped in a vicious cycle that could potentially compound upon itself. So let’s take the rating downgrade as a signal fire—a warning to the U.S. government to cut back on spending and resolve this negligent fiscal behavior.