The $2.9 trillion municipal bond market is preparing for “hundreds and hundreds” of downgrades after Standard & Poor’s lowered the U.S. one level to AA+, the first-ever reduction for the country.
S&P is likely to cut its ratings on municipal debt secured by the federal government, such as pre-refunded bonds, tax- exempts backed by U.S. agencies, and credits that are most dependent on federal spending, Peter DeGroot, head of municipal research at JPMorgan Chase & Co. (JPM), wrote in an Aug. 5 report distributed after the federal downgrade. The New York-based ratings company said it would release a statement on state and local issuers today.
“There will be hundreds and hundreds of municipal downgrades, which will not do well to bolster investor confidence,” Matt Fabian, a managing director of Concord, Massachusetts-based Municipal Market Advisors, said in a telephone interview. “Treasuries may be able to shake off a real impact from the downgrade. Munis I’m less sure about.”
Municipal issuance has fallen amid the U.S. debt-ceiling impasse. The slump and signs of a slowing economy helped drive tax-exempt yields to the lowest this year. Scheduled debt sales total about $2.8 billion this week, the slowest August week since 2003, according to data compiled by Bloomberg.
S&P’s move “highlights the much-less advanced pace of fiscal consolidation in the U.S., relative to Europe and the U.K.,” John Normand, the London-based global head of foreign- exchange strategy at JPMorgan Chase & Co., wrote in a report to clients.
The dollar fell to 77.70 yen, from 78.40 on Aug. 5. The U.S. currency depreciated to $1.4357 to the euro, from $1.4282. The Dollar Index jumped 1 percent last week to 74.598.
S&P lowered the U.S. one level to AA+ while keeping the outlook at “negative” as it becomes less confident Congress will end Bush-era tax cuts or tackle entitlements. The rating may be cut to AA within two years if spending reductions are lower than agreed to, interest rates rise or “new fiscal pressures” result in higher general government debt, the New York-based firm said Aug. 5 after markets closed.
“The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics,” S&P said in a state
Moody’s Investors Service and Fitch Ratings affirmed their AAA credit ratings on Aug. 2, the day President Barack Obama signed a bill that ended the debt-ceiling impasse that pushed the Treasury to the edge of default. Moody’s and Fitch also said that downgrades were possible if lawmakers fail to enact debt reduction measures and the economy weakens.
Foreign exchange strategists at Barclays Capital said in a note to clients that S&P’s move may initially lead to rally in assets and currencies perceived to be a haven, such as the Swiss franc and yen, while causing currencies of economies that are depend on commodities to weaken. The dollar may also benefit from the “risk impact of the shock,” though longer-term U.S. “fiscal problems are likely to mean a weaker dollar.”
S&P had been very clear about what it wanted to see in order for the U.S. to maintain its AAA rating, and the agreement reached last week had not met those criteria,” Paul Robinson, a strategist at Barclays in London, wrote in a note to clients. “Commodity currencies look most vulnerable in the short run, again because of the risk element.”
UBS AG strategists said in a note there could be “knee- jerk” selling of the dollar and “risk assets,” especially against the franc and yen.
Finance ministers and central bankers are preparing a statement to release before the open of Asian markets in support of the dollar, the Nikkei newspaper reported, without citing anyone. Japan may intervene in the currency market if dollar falls, Nikkei also reported.
The potential for intervention in the yen and franc “complicates matters,” a currency strategist at Nomura Securities said in a research note.
Euro-region central bank governors will hold emergency talks today intended to stop Spain and Italy from becoming the next victims of the sovereign-debt crisis and limit fallout from the first U.S. credit-rating cut in history.
The central bank chiefs will meet by conference call at about 6 p.m. Paris time, said a euro-area central bank official who declined to be identified because the talks are confidential. A spokesman for the European Central Bank declined to comment. Officials from the Group of 20 held a call earlier today and G-7 finance chiefs may confer by phone as soon as morning in Tokyo before Asian markets open, Kyodo News reported, citing people familiar with the plan.
Traders cut bearish bets on the dollar last week from the highest level in more than two months as concern eased that a political stalemate in Washington on raising the U.S. debt limit would erode the value of the world’s reserve currency.
Aggregate wagers against the greenback fell for the first time since the period ended July 1, dropping to 307,321 contracts from 310,222, data from the Commodity Futures Trading Commission in Washington show. Futures traders added to bets the dollar will weaken against the yen, Swiss franc, Canadian dollar, U.K. pound, New Zealand dollar and ruble. Wagers on a drop versus the euro, Australian dollar and Mexican peso were trimmed.
Volatility in currency markets rose last week to the highest since March, with the JPMorgan Global FX Volatility Index reaching 12.31 on Aug. 4 before easing to 12.18 a day later.
The committee of bond dealers and investors that advises the U.S. Treasury said the dollar’s status as the world’s reserve currency “appears to be slipping” in quarterly feedback presented to the government on Aug. 3.
The U.S. currency’s portion of global currency reserves dropped to 60.7 percent in the period ended March 31, from a peak of 72.7 percent in 2001, data from the International Monetary Fund in Washington show.
“The idea of a reserve currency is that it is built on strength, not typically that it is ‘best among poor choices’,” page 35 of the presentation made by one member of the Treasury Borrowing Advisory Committee, which includes representatives from firms ranging from Goldman Sachs Group Inc. to Pacific Investment Management Co. “The fact that there are not currently viable alternatives to the U.S. dollar is a hollow victory and perhaps portends a deteriorating fate.”
Members of the TBAC, as the committee is known, which met Aug. 2 in Washington, also discussed the implications of a downgrade of the U.S. sovereign credit rating. “None of the members thought that a downgrade was imminent,” according to minutes of the meeting released by the Treasury.
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