Bloomberg News

Dollar Surges With U.S. Bonds Defying Debt Downgrade by S&P

October 05, 2011

(Updates prices beginning in second paragraph.)

Oct. 5 (Bloomberg) -- Two months after Standard & Poor’s said the U.S. was becoming less creditworthy, the market value of assets denominated in dollars is surging.

While about $6 trillion has been erased from the market value of global equities since Aug. 5, when the New York-based unit of McGraw-Hill Cos. cut America’s credit rating to AA+ from AAA, the dollar has appreciated 8.1 percent against the world’s most-traded currencies, according to data compiled by Bloomberg. Instead of depreciating, Treasuries returned 6.4 percent last quarter, the most since the three months ended December 2008.

“The U.S. dollar is the only relevant reserve currency and bastion of safety,” Matt Toms, the head of U.S public fixed- income investments at Atlanta-based ING Investment Management, which oversees more than $500 billion, said Sept. 28 in a telephone interview. “The market views the risk of not being paid back as miniscule.”

When S&P lowered its outlook for the nation in April, it cited the “dollar’s preeminent place among world currencies” as a reason for keeping the AAA rating, mentioning the word “dollar” four times in a statement. When it downgraded the U.S. in August, the company all but disregarded the dollar, mentioning it once in the announcement in the 15th paragraph.

Markets are saying S&P was right the first time. The dollar beat stocks, bonds and commodities last month for the first time since May, showing that in times of turmoil, there are no safer assets than those denominated in the world’s reserve currency. Central banks have 60 percent of their foreign-exchange holdings in the U.S. currency, compared with the euro’s 27 percent, the next highest.

Best to Own

The dollar was the best performing developed-nation currency besides the yen, gaining 7.4 percent in the past month next to nine peers tracked by Bloomberg Correlation-Weighted Currency Indexes. It strengthened 5.5 percent against the euro, 9.2 percent versus the Australian dollar and 17 percent compared with the Swiss franc.

Europe’s sovereign debt crisis and falling interest rates from Brazil to Turkey helped the dollar rally as investors retreated from riskier assets. The weakening U.S. economy has also contributed to the currency’s strength.

The gap between the cost of insuring German and U.S. debt against default rose to the highest on record amid growing concerns that a default by Greece would drag the 17-nation euro region into another recession, according to data compiled by Bloomberg going back to 2008. Greek two-year note yields have climbed to 62 percent from 12.6 percent in January.

Not Positive

“Things in Europe are likely to drive the rest of the world at this point and not in a positive way,” Brian Schneider, senior portfolio manager and head of U.S. rates in Louisville, Kentucky, for Invesco Fixed-Income, at Invesco Ltd., which oversees $653 billion, said Sept. 27 in an interview.

Brazil’s central bank cut its so-called Selic target to 12 percent from 12.5 percent at the end of August. Turkey reduced its key rate to 5.75 percent in August from 7 percent last year.

U.S. unemployment has hovered at about 9 percent for the past two years, prompting the Federal Reserve to take unprecedented steps to reduce borrowing costs and President Barack Obama to propose a $447 billion stimulus plan. The economy grew 1.3 percent in the second quarter according to revised government figures released Sept. 29.

Auction Demand

Even with market rates near the lowest on record, demand at U.S. government debt auctions surged last week. Treasuries outperformed three of the five biggest AAA economies since the downgrade, trailing U.K. gilts and German bunds, according to Bank of America Merrill Lynch index data. Yields on benchmark 10-year Treasuries fell to a record 1.67 percent on Sept. 23 from 3 percent in July.

“You saw the market buying Treasuries hand over fist while trying to get out of other assets” right after the ratings move, Invesco’s Schneider said. “If the U.S. was only AA+, what did that make the rest of the world?”

S&P announced the change after weeks of disagreement between the Obama administration and Congress over raising the nation’s borrowing limit to avoid a government default. On Aug. 2, they reached an agreement to increase the $14.3 trillion debt ceiling and put in place a plan to enforce $2.4 trillion in spending reductions over the next 10 years, less than the $4 trillion S&P had said was needed to keep the AAA ranking.

The ratings cut after markets closed on a Friday drew criticism from Obama and from billionaire Warren Buffett, who said the U.S. should be “quadruple-A.” John Bellows, acting assistant Treasury secretary for economic policy, said S&P had made a $2 trillion “mistake” in its math and then changed the rationale for its decision to politics instead of financial metrics.

Stable Outlook

Moody’s Investors Service affirmed its top U.S. ranking on Aug. 8 and has a negative view of the debt. Fitch Ratings kept its AAA credit rating on Aug. 16 and said the outlook is stable, citing the nation’s central role in the global financial system and the flexible, diverse economy.

S&P on Aug. 22 named Citibank NA Chief Operating Officer Douglas Peterson as president, replacing Deven Sharma who will leave at the end of the year to “pursue other opportunities.”

Among AAA countries, “there should be no genuine question within policy makers’ circles of the paramount importance of honoring the government’s market debt obligations in full, on time, and unconditionally,” S&P said Sept. 15 in a report. The U.S. political process contrasts “unfavorably and increasingly” with top-ranked nations, S&P said.

A survey of 1,031 Bloomberg subscribers showed that 67 percent backed the downgrade, though 35 percent also said grades given by rating firms aren’t reliable.

‘Too Political’

“Their action was too political,” Chris Rupkey, chief financial economist of Bank of Tokyo-Mitsubishi UFJ Ltd. in New York, said in a telephone interview on Oct. 3. “Normally if there’s a downgrade, yields on the sovereign debt tend to go up. Just the opposite happened in this case. I don’t know if people are taking the downgrade seriously.”

The U.S. has shown willingness in the past to raise taxes and cut expenditures to reduce deficits. President Bill Clinton signed a law in August 1993 that increased the top individual tax rate to 36 percent from 31 percent, and a 10 percent surtax on those who make $250,000 a year or more boosted the top effective tax rate to 39.6 percent, paving the way for a budget surplus in 1998.

“It’s the depth, the liquidity and the ability to pay that matters, is what the market said” after the S&P downgrade, Mark Luschini, chief investment strategist at Philadelphia-based Janney Montgomery Scott LLC, which manages $54 billion, said yesterday in New York. “The S&P approach was subjective.”

Overseas Holdings

The U.S. sold five-year debt on Sept. 28 at yield of 1.015 percent, the lowest ever. Two-year Treasuries were auctioned at a yield of 0.249 percent, compared with a record low 0.22 percent on Aug. 23. The bid-to-cover ratio, which gauges demand by comparing bids with the amount of securities offered, was 3.76 in last week’s two-year sale, the most since September 2010.

While total overseas holdings of Treasuries fell to $4.48 trillion in July from a record $4.51 trillion in May, China increased its U.S. debt securities to $1.17 trillion, the highest ever.

Treasury yields have also been kept down by the Federal Reserve, which has left its target rate for overnight loans between banks at a record low since December 2008 and last month said it will extend the maturities of its $2.64 trillion of securities holdings to reduce longer-term borrowing costs. In August, the central bank promised to keep its target rate for overnight loans between banks near zero through mid-2013.

Fed Measures

The Fed’s measures are “having some impact” on yields, Tom Higgins, global macro strategist in Boston at Standish Mellon Asset Management Co., which oversees about $85 billion in fixed-income assets, said Sept. 28 in a telephone interview. “Even with the downgrade, Treasuries are deemed the safest place to put your money.”

The dollar’s share of global currency reserves dropped to 60.2 percent in the period ended June 30, the least since March 31, 1999, as far back as the IMF provides data. That compared with 61.5 percent in the fourth quarter, according to the IMF’s quarterly Composition of Official Foreign Exchange Reserves report on Sept. 30. The euro’s share rose to 26.7 percent, from 26.6 percent, while the yen rose to 3.9 percent of the total.

S&P may downgrade the U.S. in the coming year. There is a one-in-three chance of another rating cut, though a change may not occur until late 2012 or 2013, John Chambers, a managing director of S&P, said Sept. 15 at the Bloomberg Markets 50 Summit in New York.

Though he didn’t disagree with the August S&P downgrade, Higgins of Standish Mellon said he still views the U.S. as AAA because it’s the reserve currency. “Right now there’s no alternative to the U.S. dollar.”

--With assistance from Zeke Faux, Dan Kruger and Cordell Eddings in New York and Jesse Hamilton in Washington. Editors: Philip Revzin, Dave Liedtka

To contact the reporter on this story: John Detrixhe in New York at

To contact the editor responsible for this story: Dave Liedtka at

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