The possibility--however remote--the U.S. Treasury's rating could be downgraded one notch to double-A has fixed-income professionals speculating over some of the potential effects of such a move. They said while a downgrade is unlikely, even talk of it could chip away at the 10-year Treasury's position as the gold standard and benchmark of choice for the bond market.
"The Treasury market is clearly not what it used to be. We're seeing more and more international players that don't really care how bonds are priced off Treasuries and are pricing off swaps or LIBOR instead," said David Brownlee, fixed-income portfolio manager at Sentinel Advisors, a mutual fund company.
The talk comes amid a report last week in The Wall Street Journal questioning the U.S.'s previously unassailable rating due to massive deficits and the weakening dollar. While Moody's Investors Service, Standard & Poor's and Fitch Ratings have not made a move to downgrade the government's rating and insist they won't in the near term, a small agency raised eyebrows by arguing in a research note the Treasury should be downgraded. The rating agency, Egan-Jones Ratings, is pending recognition as a Nationally Recognized Statistical Rating Organization by the Securities and Exchange Commission (see story, page 4).
However, other managers do not see the market moving away from using the 10-year as the main fixed-rate benchmark. "Realistically, what else is there?" said Sai Choy, portfolio manager at Fischer Francis Trees & Watts. He sees swaps as more of a valuation tool and thinks the bond market will continue to use the 10-year as a benchmark even in the case of a downgrade. He speculated a downgrade would raise yields on the 10-year Treasury by as little as five basis points because he does not see the move from triple-A to a high double-A as being a large move and predicted the market would adjust to any downgrade.
