This may be one of the most uncertain times that Treasury investors have ever faced. If the dilemma didn’t appear on August 4, 2011, it’s the day it deepened considerably. On that day, Standard & Poor’s (S&P) took away the triple-A rating that it had given to U.S. Treasuries 70 years earlier. S&P downgraded long-term U.S. debt to AA+, a score that ranks below more than a dozen governments. * S&P also put the new grade on “negative outlook,” meaning the U.S. had little chance of regaining the top rating in the near term.
Behind the credit downgrade were record U.S. government indebtedness, trillion-dollar federal budget deficits, and a deeply divided Congress that threatened to force the government to shut down and default on its debt, an event that had never happened in U.S. history.
Since August 2011, very little has changed. The Treasury’s debt still stands at record levels, and the federal budget is still running a trillion-dollar deficit with no end in sight. The only change is that as the Treasury once again approached its legal debt limit this January, some politicians who have been demanding spending cuts and reforms of Social Security and Medicare put off a debt limit and default showdown with a temporary suspension of the debt limit.
As troubling as it may be, the question of whether Treasuries will default isn’t the only issue causing investor uncertainty.
When reviewing U.S. Treasuries, consider:
- Only S&P downgraded. While the other two major credit rating agencies, Moody’s and Fitch, issued warnings, S&P remains the only agency to take away the Treasuries’ top rating. So there is no consensus among the experts as to whether the underlying safety of U.S. government debt has become less reliable. On the other hand, S&P faced a barrage of criticism for its downgrade, with charges coming from even Wall Street that the action was more political than financial, and it may have been motivated by S&P’s desire to regain respect after failing to downgrade trillions of dollars of mortgage-backed securities before they crashed.
- The global markets still love Treasuries. Within days of S&P’s downgrade, Warren Buffett announced that the action was meaningless to him. “I wouldn’t dream of putting my [cash holdings] anywhere else,” said the chairman of Berkshire Hathaway, which owns a state in Moody’s. But it wasn’t only Buffett who maintained his faith in Treasury securities; so did the rest of the world’s investors, who not only continued to pour money into Treasuries, but did so at an accelerating rate. The trillions of dollars in additional purchases pushed the yield on the bench-mark 10-year Treasury down from 2.4% on the day of S&P’s downgrade to as low as 1.82% before the end of the year, a near-record low (Source: U.S. Treasury, 2012). Even now, Treasury rates remain near record lows, meaning they have yet to lose any significant confidence in the global markets. In effect, what the world is saying is that it believes that Washington will finally overcome it fiscal problems, and the U.S. economy still remains the world leader.
- Rates have almost nowhere to go but up. While the stampede into Treasuries over the last two years is a sign of confidence, it’s a two-edged sword. That’s because with yields at all-time lows, they almost have nowhere to go but back up, and when and if they do, the prices on existing bonds will go down. The result could be large losses for any investors who sell their Treasuries before they mature. Meanwhile, even if you’re the kind of investor who holds bonds until maturity, buying Treasuries today means you have to settle for minuscule yields in comparison to just five years ago.
At current yields, depending on your needs, Treasuries might not make sense for your next bond buy. Please call if you’d like to discuss this in more detail.
* Regarding S&P ratings, AAA is the highest possible credit rating, with principal and interest considered very secure. AA is considered high quality, differing from the highest rating only in the degree of protection offered to bond-holders.
Copyright © Integrated Concepts 2013. Some articles in this newsletter were prepared by Integrated Concepts, a separate, nonaffiliated business entity. This newsletter intends to offer factual and up-to-date information on the subjects discussed, but should not be regarded as a complete analysis of these subjects. The appropriate professional advisers should be consulted before implementing any options presented. No party assumes liability for any loss or damage resulting from errors or omissions or reliance on or use of this material.