Goldman's Take On S&P's Warning

Tyler Durden's picture

Goldman's opinion on the S&P action took just a little longer than PIMCO to be distributed to clients: 108 minutes. Not surprisingly, after eagerly pushing rating agency opinions to clients buying CDOs from Goldman, the firm's economists are now eagerly trying to talk it down: "Clearly, the US fiscal situation is unsustainable unless a large,
multi-year fiscal tightening is implemented.  However, there is no
information in today’s report about the fiscal situation that was not
already known.  Academic research has generally found that rating agency
actions lag market pricing, rather than lead it. 
Any relevance of
today’s announcement is a) as a potential catalyst for renewed market
focus on these issues, particularly if the other agencies follow suit,
b) a signal of a nonzero probability of an outright ratings downgrade
over the next few years." And who was the research conducted by? Moody's? A Princeton Ph.D. academic? Yes, we know the country is screwed. But we can sure do without this condescending BS.

From Goldman:

BOTTOM LINE:  Ratings agency Standard & Poor’s revised the outlook for its US sovereign debt rating to “negative” from “stable”, signaling the possibility of an outright ratings downgrade within a couple of years.

 
KEY POINTS:

1.     Standard & Poor’s changed its outlook on US Treasury debt today to “negative” from “stable” , citing a “material risk that US policy makers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013” and concern that even once agreement is reached, it might still “take a number of years before the government reaches a fiscal position that stabilizes its debt burden.”   S&P notes that even in its “optimistic” macroeconomic scenario, “the US’s fiscal profile would be less robust than those of other AAA rated sovereigns by 2013.”

2.     S&P’s US sovereign rating remains AAA.  Moody’s and Fitch continue to have the US sovereign debt rating at AAA and stable outlook.

3.     A rating outlook change has no immediate implications—in particular, it does not make a difference in terms of current bond mandates.  It does flag the possibility of an outright ratings downgrade within the next few years, which would have material market implications for investors required to invest a specific portion of their holdings in AAA securities.   According to S&P, the negative outlook “signals that we believe there is at least a one-in-three likelihood that we could lower our long-term rating on the U.S. within two years.”  (Historically, the frequency of ratings downgrades for AAA sovereigns on negative watch is actually much lower than 1 in 3 over this horizon, although there is of course no guarantee that will remain true in the future.) 

4.     S&P made a similar change with respect to the UK outlook in May 2009, lowering its outlook to negative.  It reaffirmed the negative outlook last summer, citing a “a material risk that the UK’s net general government debt burden may approach a level incompatible with the AAA rating.”   Thus far, however, the UK has retained its AAA long-term sovereign rating.

5.     Clearly, the US fiscal situation is unsustainable unless a large, multi-year fiscal tightening is implemented.  However, there is no information in today’s report about the fiscal situation that was not already known.  Academic research has generally found that rating agency actions lag market pricing, rather than lead it.  Any relevance of today’s announcement is a) as a potential catalyst for renewed market focus on these issues, particularly if the other agencies follow suit, b) a signal of a nonzero probability of an outright ratings downgrade over the next few years. 

6.     Since the announcement, and as of this writing, the 10-year Treasury yield is up approximately 4 basis points and the S&P 500 has sold off about 1%.  US sovereign CDS are trading at approximately 50bp, up 7bp (versus a level of approximately 10bp pre-financial crisis and a peak of 100bp in early 2009).