Thursday, August 18, 2011

The Anomaly of US Credit Rating Downgrade!

The credit rating downgrade of US Govt. seemed like an exercise in signalling alone. In fact funnily enough the flight of safety that will ensue thus will push up the prices of US treasuries thus reducing the yields on them. Hence the US treasuries would probably become the first security ever to increase in value after a credit rating downgrade!!
That of course is only half the story. The price of a security is mostly about its economic value. However, there are some overlays such as liquidity, special currency status and home country bias that may produce a fundamentally opposite outcome to that on account of inherent economic value alone. This is indeed the case with US Govt debt. Owing to the special status of dollar as the global currency, the unmatched depth and liquidity of the US Treasury bond market and the fact that US in indeed the home to a large proportion of global investors, the treasuries can indeed rally despite (and in fact because of) the credit rating downgrade!

Where do we go from here? Will the US go into long-lasting recession (or even depression)? Will the Euro survive? Will China slow down? Will India slow down? Will global inflation lead to continued tight money policy in emerging economies thus leading to a period of anaemic growth even amongst the BRIICS?

Whatever be the ultimate diagnosis and the result thereof, I often think that the worries as well as enthusiasm get played up significantly in our times - thanks largely to media, social networking and the presence of highly liquid markets for assets. While that may sound like a nuisance to some, it also smells like an opportunity - if only one can keep one's head when everyone around is losing theirs!

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