Keep Fitch's Warning in Perspective

The global head of Fitch's sovereign ratings warned that the continued US government shutdown could jeopardize the AAA-status the rating agency grants America.  It spurred little market reaction (and for good reason).  

First, the rating cut is not imminent, though some of the headlines suggest otherwise.  Fitch's McCormack though was clear:  " If the shutdown continues to March 1 and the debt ceiling becomes a problem several months later, we may need to start thinking about the policy framework...and whether all of that is consistent with triple-A."

Second, S&P took away the US AAA rating in 2011.  It still stands at AA+.  The impact was negligible.  A Fitch downgrade would look bad, but there is still no compelling alternative to the US Treasury market in terms of depth, breadth, and transparency.  Third, Fitch warned last year that it might take away the AAA rating, but it did not do so.   

The more immediate problem is not the rating but the demand for US Treasuries.  As we noted over the weekend, the drop in yields may dampen interest at upcoming auctions.  Sure enough, yesterday' auction of $38 bln three-year notes saw the lowest bid-cover since 2009.  Tne indirect bidders, which includes some asset managers and foreign institutions, took the second lowest amount in the past two years.  

Today the Treasury sells $24 bln 10-year notes, and tomorrow it will return with a $16 bln sale of 30-year bonds.  The 10-year yield has risen by about 20 bp over the past week, but at 2.73%, it still looks rich. Has the world or the US macro condition really changed that much since, say mid-November, when the 20-day average yield was 3.15%? The concession in the 30-year bond is less as the yield is about 14 bp off the low seen last week.  It is trying to re-establish a foothold above 3%.  The coupon sales ease next week with only 10-year TIPS on tap.  

The flatness of the curve may also discourage demand at the long end.  Consider the yield pickup from two years to seven years is only six basis points.   Is one really being compensated for the extra risk?  The 10-year yield is less than 15 bp on top of the two-year note.   The 30-year yield is about 27 bp above the 10-year.  Light participation in the auctions will leave supply in the dealers' hands, and they may have to mark down their inventory to distribute it.  

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