2023-08-03 06:42:58
US bond prices rose yesterday (Wednesday), despite the downgrading of the US credit rating by Fitch. Thus, the market operates in the opposite direction from the theory regarding a drop in credit rating, which should lead to selling pressures, when in reality buying pressures have actually been created. Government bonds in the Eurozone also reacted with slight increases, after the increases in American bonds.
Two-year Treasury bond yields fell 0.05%, and ten-year bond yields fell 0.02%. The slight decrease in yields is the other side of a slight increase in the prices of these bonds.
According to Bloomberg, the downgrade from AAA to AA+ is not without effect, and it increases the volatility in the stock market as well as in the bond market. The opposite reaction in the market may be explained by the fact that US government bonds are in any case considered a “safe island” during turmoil in the markets. That is, this rating change is not expected to lead to an automatic sale of bonds by funds that have an investment policy that is formally anchored in the credit ratings of the assets in the investment portfolio.
Another explanation is the lack of available alternatives to invest in instead of American bonds. Only Germany has sovereign bonds with the highest rating (AAA), and a number of much smaller economies – Denmark, the Netherlands, Sweden and Norway. That is, these governments do not raise enough debt to constitute A challenge to the demand for US debt. Economists from Goldman Sachs Bank wrote that “because US bonds are such an important asset, many investment rules of funds require the purchase of these bonds specifically, and not of ‘AAA-rated sovereign debt'”.
The downgrade itself occurred following the difficulties of the United States to forge a bipartisan agreement on increasing its debt ceiling. A debt ceiling is an unacceptable policy in the world, and its presence in the United States does create a risk of debt default due to an artificial political limit. The ceiling is mainly used by Republican politicians as a bargaining chip against the Democrats. The Republicans do not hesitate to use it, even though it is a very dangerous measure. If an American debt default occurs – the possibility that is considered the least likely in the global capital market – it could cause a dangerous financial collapse all over the world.
The downgrade in 2011 was also accompanied by a prolonged increase in the value of the bonds
A downgrade of the American debt took place under similar circumstances in 2011, after a long struggle regarding raising the debt ceiling during the time of President Barack Obama. The downgrade at that time caused a strong backlash in the market against the expectation of downgrades following the downgrade and precisely to increased purchases of American bonds, which raised their price and lowered their yield for an extended period. It is difficult to determine whether the downgrade was the driver of the increased demand. Since this downgrade was a continuation of an existing trend, it can be concluded, at the very least, that the downgrade did not cause a change in trend.
US bond yields in 2011. The drop in yields reflects an increase in price and demand (screenshot: Bloomberg)
In the Obama administration, they attacked the credibility of the S&P company that lowered the rating at the time, and found in the agency’s calculations a considerable error, in the amount of 2 trillion dollars.
The chance of downgrading Israel and its consequences
Israel’s economy differs from the United States in terms of size and importance, which helps create a consensus among economists and journalists in Israel, according to which a downgrade to Israel’s debt means an economic disaster and a dramatic increase in the interest payments that Israel pays on the debt. Things get mixed up with estimates according to which the legal reform hurts Israel economically in a direct way, at the same time and even without connection to the credit rating.
The latest updates from the rating companies did not harm Israel’s credit rating, but warned that such harm is possible, if the social tension in Israel continues regarding legislation to weaken the justice system initiated by the government. On the other hand, strong economic data about employment and growth in the Israeli economy, and low inflation rates relative to the world, were praised by the rating companies.
From a simple economic point of view, the credit rating in itself has almost no effect on the government’s interest payments, since the rated Israeli debt in foreign currency, which is the debt that interests investors in the world, encompasses less than 15% of Israel’s total debt. Most of the debt is denominated in shekels, and a large part of it is not negotiable at all. The shekel debt is less affected by credit rating, because it plays a critical role for private financial entities in Israel, a role reminiscent of the role of American bonds in the global economy.
However, the credit rating may have a negative effect on start-up companies trying to raise money from foreign investment funds, as well as a negative sentiment for any Israeli company trying to raise foreign currency debt.
On the other hand, the Bank of Israel is the one responsible for a significant increase in the financing costs of businesses and the government in the economy, through the increase in interest rates, with a much greater force than a downgrade can cause. The Bank of Israel interest rate creates an available alternative for investors looking for low-risk assets, which obliges the other parties in the market to offer higher interest rates in order to attract investments. The dramatic change in capital raising costs led by the Bank of Israel also applies to Israeli government bonds. At the same time, the Bank of Israel itself announced today that the increase in interest rates it has adopted is causing damage to economic stability in the financial sector in Israel.
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