Thursday, November 17, 2011

Why The AAA Rating of U.S. Debt Is In Jeopardy

Over at Creditwritedowns, Edward Harrison posted a chart taken from a recent article in Die Welt showing the indebtedness of the U.S and the other nations with AAA rated sovereign debt. Glancing at the numbers shows that the U.S. has both the worst debt and deficit ratio to GDP of any nation that has maintained a AAA rating. This data clearly illustrates why the AAA rating of the U.S. is in danger. As the ratio of debt to GDP increases, so does the risk to bond holders. 

For reference, the downgrade of U.S debt by one of the ratings agencies, Standard & Poors, had no impact on interest rates, so a downgrade by itself  will not result in higher yields being required to sell U.S. issued debt.  Despite the S & P downgrade, U.S debt is still considered AAA because it still maintains that rating from other ratings agencies. But if they all downgrade the U.S. debt, the AAA rating will be lost. A failure by the Deficit Super Committee to come up with a plan to reduce the deficit could lead the other rating agencies to reconsider whether the U.S. debt really deserves a AAA rating.  

Unfortunately, a continued stalemate by the Deficit Super Committee could have serious consequences for the cost of funding U.S debt if their inaction leads to: 1) the AAA credit rating of the U.S. being downgraded; and 2) a loss of confidence in the perceived value of U.S issued debt. Given that $11 billion dollar of TIPS are being offered today and $99 billion in notes are being auctioned on 11/21-11/23, even a slight increase in the yield required to sell the bonds will cost U.S. taxpayers dearly. Just a 0.1% increase in the average yield would increase the annual interest payments on this debt by $10 million.

1 comment:

  1. The $11 billion TIPS auction today (11/17) resulted in a mild up tick in yield and a small decline in coverage ratio. The 10-year TIPS sale drew a yield of 0.099 percent, compared to the Sept. 22 auction of $11 billion at which the securities sold at a record low yield of 0.078 percent. The bid-to-cover ratio, which gauges demand by comparing the amount bid with the amount offered, was 2.64 versus an average of 2.79 for the past 10 sales.