Bloomberg News

Does America Know Downgrade Means 3.25% Faster Than Saying AA

July 29, 2011

July 29 (Bloomberg) -- The unanticipated rally in U.S. Treasuries while lawmakers wrangle over rising the nation’s borrowing limit would soon evaporate if a collapse of talks leads to a default, according to UBS AG’s Mike Schumacher.

“We think if there is really a blow off event in Washington, so let’s say all the discussions completely fall apart over the next few days, you could possibly see the 10-year yield go up to 3.25 percent or 3.3 percent,” Schumacher, head of global rates strategy at UBS AG in New York, said in a July 27 radio interview on “Bloomberg Surveillance” with Tom Keene.

Ten-year notes rallied the most in two weeks today, pushing the yield to as low as 2.84 percent, as investors bet the U.S. will avoid a default even as lawmakers were deadlocked and economic growth faltered. Standard & Poor’s, which has given the U.S. a top AAA ranking since 1941, said on July 14 that the chance of a downgrade is 50 percent in the next three months and may cut the rating as soon as August if there isn’t a “credible solution” to reduce the nation’s deficit.

“$4 trillion would be a good down payment,” John Chambers, chairman of S&P’s sovereign rating committee, said in a video interview distributed by the New York-based ratings firm yesterday. “A grand bargain of that nature would signal the seriousness of policy makers to address the fiscal situation in the U.S.”

The government is inching closer to running out of cash before an Aug. 2 deadline to raise the $14.3 trillion debt ceiling. House Republican leaders scrapped a vote on the debt ceiling bill late yesterday, fueling concern a compromise by the two parties won’t be reached before the deadline and casting doubt on whether the Treasury can sell more debt.

Senate Talks

“You have to remember the whole discussion about the deficit reduction is comparatively small versus the entitlement question,” Schumacher said in a telephone interview today. “If Congress can’t its arms around a smaller one, how can it tackle a bigger one?”

As the House deadlocked, Senate Majority Leader Harry Reid said today he has asked Senate Republican leader Mitch McConnell to meet with him and “negotiate in good faith knowing the clock is running down.” The Treasury Department has set an Aug. 2 deadline for raising the $14.3 trillion debt limit to avert a default.

“If we don’t get a big deal, let’s say it’s a $1 trillion reduction in the deficit, then the economic impact probably would be fairly small,” Schumacher said in a telephone interview. “The second order effect is people would have concerns of whether the U.S. can ever grapple with entitlements.”

‘Getting a Resolution’

Yields on 10-year notes tumbled 10 basis points, or 0.1 percentage point, to 2.84 percent, the lowest since July 12, at 12:28 p.m. in New York, according to Bloomberg Bond Trader prices. Yields are down 12 basis points this week and 32 basis points this month. The 3.125 percent securities due in May 2021 increased 7/8, or $8.75 per $1,000 face amount, to 102 13/32.

“No one expects the U.S. will not be paying its debt,” said David Semmens, a U.S. economist at Standard Chartered Bank in New York. “As we get into the weekend, people will be focused on getting a resolution to the debt crisis, but it also brings the focus back to the weak economic growth we are seeing in the U.S.”

The Treasury will give priority to making interest payments to holders of government bonds when due if lawmakers fail to reach an agreement to raise the debt ceiling, according to an administration official. The official requested anonymity because no announcement has been made.

GDP Revision

The U.S. has said about $90 billion in debt matures on Aug. 4 and more than $30 billion in interest comes due Aug. 15. Overall, more than $500 billion matures in August.

“A smaller than expected deal would be bad for the Treasury market,” said Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia. “Very few people think the deal will be large enough to avoid a downgrade, a scenario that’s almost priced into the market.”

Gross domestic product climbed at a 1.3 percent annual rate following a 0.4 percent gain in the prior quarter that was less than earlier estimated, Commerce Department figures showed today in Washington. The median forecast of economists surveyed by Bloomberg News called for a 1.8 percent increase.

“There’s been a consistent overestimation of economic output,” LeBas said in a telephone interview. “The Treasury market is responding far more to that than rating risk.”

-- With assistance from Susanne Walker in New Yokr. Editors: Dave Liedtka, Robert Burgess

To contact the reporter on this story: John Detrixhe in New York at jdetrixhe1@bloomberg.net

To contact the editor responsible for this story: Dave Liedtka at dliedtka@bloomberg.net


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