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The historic US downgrade: questions and answers
Some of the immediate impacts of Standard & Poor's historic downgrade of the US credit rating are becoming known. But looking further ahead, many questions remain.
Since Friday we've seen an intensification of the stock market crash, a weaker dollar and falling US treasury yields as investors take stock of the decision from Standard & Poor’s to downgrade the United States’ AAA credit rating.
The impact of the downgrade to AA+ is gradually becoming clearer. Yet visibility remains severely impaired.
We do know the downgrade is more symbolic than anything else…
This is not a default and from that perspective, economists point out the one notch downgrade is close to being irrelevant.
The timing was bad, coming as it did at the end of the worst week for equities since the 2008 crisis, with sentiment on a knife-edge and investors panicking.
It’s also more about politics than economics, much to the anger of several major investors who view S&P’s decision as a reflection of the political judgement of one institution. In its statement on Friday, S&P said: ‘The political brinksmanship of recent months highlights what we see as America's governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed.’ The Senate banking committee is now reportedly scrutinising the decision.
Warren Buffett told CNBC on Monday that, ‘Our currency is not AAA, and in recent months the performance of our government has not been AAA, but our debt is AAA.’
That said, the simple fact is that US politicians have failed to bring their debt under control.
…but we don’t know if more will follow
The knock-on effects of the downgrade are already being seen, with institutions reliant on US guarantees facing predictable downgrades, including Israeli sovereign bonds and the debt of Fannie Mae and Freddie Mac, the mortgage finance giants.
Of the other two major rating's agency, Moody's has reiterated its warning that the US will be stripped of its prized AAA-rating by 2013 if its fiscal or economic outlook deteriorate further. Fitch Ratings has said that it expects to finish its review of US sovereign credit ratings by the end of August.
As Paul Atkinson of Aberdeen Asset Management points out, history shows that subsequent upgrades for dethroned AAA rated nations take between eight and 18 years and ‘follow a long period of fiscal retrenchment, backed by political will’.
A bigger continued focus will be the state of the US economy…
Whatever ratings actions are taken, the US is not going to default and markets will draw their own conclusions independent of S&P.
Recent weak economic data, and what that tells us about the poor strength of the US economic recovery has been a bigger driver of market falls in the past week, as has the eurozone debt crisis. These are real issues needing real measures from governments. The downgrade – which did not come as a surprise to markets – adds to the instability fostered by the debt problems.
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