If America were another country, say some European nation, a credit rating downgrade would probably send investors fleeing from the bond market. But that hasn’t been the case for the United States. Since Standard & Poor’s downgraded the country’s credit rating from AAA to AA+ fixed income investors have flocked to U.S. treasuries.
As equity markets plummeted on Monday (August 8), bond prices made significant gains. The 10-year treasury jumped about 2.4%; the 30-year bond climbed 3.22%.
Why would people be buying an asset that was just downgraded? Michael Schumacher, a strategist at UBS told Reuters that treasuries are still a low-risk asset and that most bond investors expected a downgrade to happen, so they weren’t shocked when it came. “On the equity side, it seems to have been more of a surprise,” he said.
Despite the downgrade, most analysts think the U.S. will still be able to pay its bonds when then time comes. Jim Sarni, a managing principal at L.A.-based investment firm Payden & Rygel, told CNNMoney that the downgrade has nothing to do with creditworthiness. “The problems are about cash flow and timing,” he said. “Not solvency.”
There’s another reason why investors will continue buying U.S. government bonds: there’s nowhere else to shop. The bond market in America is huge. Our southern neighbours have $14 trillion in bonds outstanding; the next biggest issuer of AAA rated debt has $2 trillion outstanding. According to Bank of Canada’s website, this country has about $593 billion in outstanding bonds and treasury bills. “There are still few alternatives to the U.S. treasury market in terms of depth and liquidity,” said Vassili Serebriakov a currency strategist at Wells Fargo in New York.
It’s not just retail or institutional investors who plan to stay in the U.S. bond market—countries like China, which owns more than $1 trillion in American debt—aren’t going anywhere either. Again, lack of liquidity in other markets means countries have no choice but to buy U.S. bonds. Plus, the Greenback is still considered the globe’s currency and if there’s a massive selloff in bonds, the dollar will plummet.
Many countries have reaffirmed their commitment to U.S. debt. Japan, the second largest holder of U.S. bonds, has said it has no plans to stop buying American treasuries; South Korea says it’s not changing its bond buying strategy; Russia has said it plans to ignore the downgrade and others have stated that American bonds are still on the menu.
Clearly, investors and governments still have confidence in the U.S. bond market. Now, if only some of that faith could rub off on equity investors…