Does The Bond Market Care If The US Loses Its AAA Rating?

If you have been watching popular media, you might have been left with the impression that the bond market was taken to the woodshed last week on fears that the US would lose its AAA credit rating. In reality investors fled government debt when a reverse auction produced a bid to cover of 6.17 while at the same time the Treasury announced $101 billion in supply for this week. To add insult to injury, Bill Gross turned, uncharacteristically, into a bully.

The markets took seriously Mr. Gross’ assessment that the bond market rout was due to investors fearing the US will lose its AAA rating. However, loss of its AAA is remote in the near term and in fact, may be a potential buying opportunity.

Viewed in the context of the most recent FOMC minutes and jobless claims, this is exactly the type of event the Fed was referencing when they discussed increased quantitative easing. Higher rates and rising continuing claims are not the data that makes a central banker sleep well.

If you need hard data to make for a restful night, take a look at the following chart.

This chart depicts the log change in the 10 year bond yield over the last year. The log change is similar to percentage change in that it provides a mechanism for comparing the severity of changes at different price levels. The best way to think of this chart is like the equalizer on your boom-box circa 1984; the bigger the spike, the more significant the noise.

The chart makes the markets voice clear. The move in bond yields on Thursday barely registered a blip on the “equalizer.” The two events that stand out are the Lehman Brothers bankruptcy and the initial announcement of quantitative easing. The market has spoken, and the result is a big yawn. Despite the media hype, the market clearly does not believe the US will lose its AAA rating.

Beyond the fancy mathematical manipulations and spiffy charts is common sense. A downgrade of US sovereign debt would be a de facto downgrade of ALL sovereign debt, since ALL sovereign debt is priced relative to US bonds. Therefore any downgrade would be ceremonial at best.

Disclosures: none

Subscribe by RSS Subscribe by Email