Thursday, July 28, 2011

Effect of Sovereign Debt Downgrades from AAA ($TLT)

Historically, the effect of sovereign debt downgrades from AAA has been bullish (caused interest rates to fall).

It appears that investors have tended to sell the rumor and then buy the news of a downgrade.


Stagflationary Mark said...

Thanks for posting this. It confirms what my gut was thinking (based at least partially on one tidbit of anecdotal evidence).

Taylor Conant said...

1.) Do you think the AAA rating would actually be at risk of being lost (at least right now)? If not, it's irrelevant
2.) How would you explain this phenomenon, as it's extremely counter-intuitive.

CP said...

In order to regain a AAA credit rating/fix the fiscal problem, they will have to:
raise taxes
cut spending
Both of which are bearish for equities and therefore good for bonds.

Taylor Conant said...

Why can't they just print money?

That'd be:

1.) Good for nominal value of bonds
2.) Bad for real value of bonds
3.) Get back a AAA
4.) Bullish for equities!

CP said...

I've been saying this since January 2010, here is the Hussman way of putting it:

"[It's the] short average maturity that makes the debt problematic from a long-run perspective, because it can’t be inflated away easily. In the event of sustained inflation, the debt would have to be constantly refinanced at higher and higher yields. Contrary to the assertion that the U.S. can easily inflate its debts away, it is clear that sustained inflation would create enormous risks to our long-run fiscal condition by driving interest costs to an intolerable share of revenues. At that point, any shortfall in GDP growth or government revenues would result in a rapid spike in debt-to-GDP (as Greece and other peripheral European nations are experiencing now). Prior to embarking on an inflationary course, the first thing a government would want to do is dramatically lengthen the maturity of its debts."