Asian investors are likely to retain their U.S. Treasuries holdings for now after the American sovereign credit rating was lowered, with options limited by the region’s foreign-exchange rate policies.
South Korean officials added the one-step cut in the U.S. grade by Standard & Poor’s to the agenda of an emergency meeting on global financial turmoil tomorrow, Hong Kong’s central bank said it would monitor any fallout and China’s official Xinhua News Agency said in a commentary that the U.S. must cure its “addiction” to borrowing. Chinese and Russian officials earlier this week pressed American policy makers to address the deficit.
For all the angst, policy makers from China to Japan to Southeast Asia are lured to Treasuries as a result of efforts to stem gains in their currencies against the dollar, which would impair export competitiveness. China has accumulated $1.16 trillion in the securities, while Japan’s intervention this week to sell an estimated excess of 4 trillion yen ($51 billion) presents a potential new source of demand.
“They won’t be happy about it but Asian central banks will just have to hold on and stick it out,” said Sean Callow, a senior currency strategist at Westpac Banking Corp. in Sydney. “There is pressure on them to hold on to liquid assets and there is nothing more liquid than the Treasury market. At least Treasuries have been doing well and they aren’t holding on to distressed assets.”
Treasuries Rally
Even after S&P had warned it may lower the rating from AAA, Treasuries have rallied in recent weeks as investors sought a haven amid deepening concerns that the global economic rebound may fade. Yields on benchmark 10-year notes closed at 2.56 percent yesterday, before the S&P announcement of the cut to AA+, down from 3.12 percent a month ago.
“Because the U.S. market remains the most liquid and deepest and as Europe still faces uncertainty, the U.S. market is not likely going to experience a huge sell-off, even with the one-notch downgrade,” Philippine central bank Governor Amando Tetangco said in an e-mailed statement. He added that the downgrade still leaves Treasuries within “allowable” investments for the central bank.
Tetangco added that “many still see the U.S. Treasury market as a safe heaven.”
Japan, the second-largest international investor in American government debt, sees no problem with trust in the securities, a Japanese government official said on condition of anonymity.
S&P Challenged
Moody’s Investors Service and Fitch Ratings have maintained their top grades for the U.S. The Treasury Department said the S&P decision was flawed by estimating discretionary spending levels at $2 trillion higher than the Congressional Budget Office estimates, said a person familiar with the matter who declined to be identified. S&P disputed that, saying its judgment wasn’t meaningfully affected by such spending figures.
Treasuries have been a beneficiary of a global sell-off in stocks, with yields on three-month Treasury bills dipping into negative territory this month. The Standard & Poor’s 500 Stock Index lost 7.2 percent last week to 1199.38, its lowest close since November. The MSCI World Index also fell to the weakest level since then.
U.S. gross domestic product data last month showed a 1.3 percent growth pace in the second quarter, after a near stall in the first three months of 2011. China’s manufacturing expanded the least since February 2009 last month. In Europe, prospects are clouded by policy makers’ failure to contain a sovereign- debt crisis that still threatens to engulf Italy and Spain, whose bonds have tumbled in the past month.
Diversification Risk
Over the longer term, failure by the U.S. to restrain its borrowing may spur diversification out of Treasuries. President Barack Obama this week signed a compromise bill from Congress that raised the federal borrowing limit while putting off decisions on specific budget cuts or revenue increases.
“This is clearly a wake-up call for the U.S. and those who think a downgrade doesn’t matter are in denial,” said Thomas Lam, Singapore-based chief economist at OSK-DMG, who accurately forecast when the worst U.S. recession since the Great Depression would end. “Markets will enforce their disciple if the U.S. doesn’t repair its credit rating.”
Lam, who was also the second-most-accurate forecaster on the U.S. economy for 2008 to 2009 in Bloomberg surveys, added that “the downgrade could potentially quicken the likelihood of more diversification out of the U.S.-dollar assets. At the same time, given Asia’s currency interventions, portfolio investments by central banks will continue to head to Treasuries, he said.
Further Cut
S&P kept the outlook for the U.S. grade at “negative,” citing the nation’s political process and criticizing lawmakers for failing to cut spending enough to reduce record budget deficits. The rating may be cut to AA within two years if spending reductions are lower than agreed to, the New York-based rating company said.
The current grade is two steps higher than the AA- level shared by Japan, which S&P has warned may see a downgrade, and China. S&P gives 18 sovereign entities its top ranking, including Australia, Hong Kong and the Isle of Man, according to a July report.
America’s deteriorating credit quality is a reflection of an elevated unemployment rate that has undermined revenue, fiscal stimulus packages under the Obama and Bush administrations to combat the recession, and a legacy of tax cuts by President George W. Bush and spending on wars in Iraq and Afghanistan.
Global Warning
“A downgrading of the U.S. economy is effectively a downgrading of the global economy,” Kaushik Basu, chief economic adviser in the finance ministry, told reporters in New Delhi today. “This is a warning signal whether you are in New York, New Zealand or New Delhi.”
China’s Xinhua said in its commentary that “the days when the debt-ridden Uncle Sam could leisurely squander unlimited overseas borrowing appeared to be numbered.” S&P’s decision is “telling the global investors the ugly truth,” Xinhua said. China’s Dagong Global Credit Rating Co. on Aug. 3 cut its grade for the U.S. to A from A+ with a negative outlook.
Russian Prime Minister Vladimir Putin applied similar invective this week, saying Americans “are living beyond their means and transferring part of the problems onto the world economy.” Speaking to a youth camp at Lake Seliger outside Moscow Aug. 1, he added that “in a way, they are leeching on the world economy.”
Fed Implication
The U.S. Federal Reserve will extend its program to purchase the nation’s debts and stabilize long-term interest rates after S&P’s move, Li Daokui, an adviser to the People’s Bank of China, predicted in his microblog weibo.com. Institutional investors will be forced to sell long-term U.S. debt, which may cause financial turbulence, he wrote.
Asian nations including China and South Korea said an earlier Fed stimulus effort had sparked the danger of spurring flows of speculative capital into emerging markets, causing asset-bubble risks.
China has accumulated its Treasuries holdings by restraining gains in the yuan, which has risen less than 3 percent against the dollar this year. By comparison, the Swiss franc has soared 22 percent, New Zealand’s kiwi is up 8 percent and the yen advanced 3.5 percent.
Japan Intervention
Japan’s authorities mounted their third round of intervention in the currency market Aug. 4 after the yen approached a postwar high against the dollar. The Bank of Japan late yesterday estimated that deposits held at financial institutions climbed to a total 32.3 trillion yen. The figure suggests the government sold about 4.5 trillion yen, a record, according to Yuichi Takahashi, market economist at Totan Research Co., a money-market brokerage in Tokyo.
The latest yen sales may herald “an extended period of interventions,” David Rea, Japan economist at Capital Economics Ltd., said from London yesterday after the BOJ data were released. Japan held $912 billion of Treasuries at the end of May, according to the U.S. Department of the Treasury.
In South Korea, deputies from the finance ministry, Bank of Korea, Financial Services Commission and Financial Supervisory Service will gather tomorrow to discuss the global economy and financial markets.
“The authorities will closely monitor the markets and act to keep the financial markets stable,” the finance ministry said Aug. 5. “Our focus is on capital flows and foreign exchange rate on top of stock and bond markets both at home and abroad.”
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