When Standard & Poor’s downgraded the United States’ long-term debt after markets closed on Friday, Aug. 5 to AA+ from AAA, it set off a maelstrom in the markets and from pundits. Markets opened on Monday with investors jumping out of equity positions and into the safest vehicle they could find, which was ironically long-term U.S. debt.
While the move into U.S. debt seemed counter-intuitive, Keith Springer, president of Springer Financial Advisors, says the downgrade wasn’t based on U.S. creditworthiness. "[The downgrade] signifies the end of a growth phase for the country that has lasted for decades," he says. "It [moves politicians to action] because now they have to become austere and more budget-oriented. That means less spending overall and less spending means less profit growth in the country."
Jack Broz, founder of TradeBondFutures.com, says bond traders at CME Group largely discounted the downgrade, focused more on the state of the economy and questioned the messenger. "Everyone knew the economy was in trouble and we had too much debt. The guys on the floor said, ‘S&P is the same group that said Enron was fine until the last day when it collapsed. It’s the same group that said mortgage bundles (of subprime loans) were AAA-rated.’ The trading floor said there’s no integrity in S&P," he says.
Following the U.S. downgrade, S&P also downgraded The Options Clearing Corp., The Depository Trust Co., National Securities Clearing Corp., and Fixed Income Clearing Corp. to AA+ because of their exposure to U.S. debt.
The markets responded by buying U.S. Treasuries, setting an all time high in 10-year note futures, and selling equity indexes with S&P 500 futures hitting a 12-month low.
Recent economic weakness along with the steep drop in equities led to speculation the Federal Reserve would launch a third round of quantitative easing following its August meeting. Instead it pledged to keep Fed Fund rates near zero at least until June 2013.
"It’s not a question of credit worthiness; it’s a question of growth potential in the economy and the markets. That’s why bonds and Treasuries are going up and equities are going down," Springer says.