The sovereign credit rating of the U.S. will be cut as "fiscal theater" plays out in the world’s biggest economy, according to Pacific Investment Management Co., which runs the world’s largest bond fund.
The U.S. will get downgraded, it’s a question of when, Scott Mather, Pimco’s head of global portfolio management, said today in Wellington. It depends on what the end of the year looks like, but it could be fairly soon after that.
The Congressional Budget Office has warned the U.S. economy will fall into recession if $600 billion of government spending cuts and tax increases take place at the start of 2013. Financial markets are complacent about whether the White House and Congress will reach agreement on deferring the so-called fiscal drag on the economy until later next year, Mather said.
In a base case of President Barack Obama being re- elected and Congress becoming more Republican, there is a high likelihood an agreement doesn’t happen in a nice way, and we have disruption in the marketplace,"he said.
Policy makers probably will agree on cutbacks that would lower economic growth by about 1.5 percentage points next year, Mather said. They may roil markets by discussing scenarios that would lead to a 4.5 percentage-point fiscal drag, he said.
Budgetary MethBill Gross, manager of Pimco’s $278 billion Total Return Fund, this month said that the U.S. will no longer be the first destination of global capital in search of safe returns unless fiscal spending and debt growth slows, saying the nation "frequently pleasures itself with budgetary crystal meth." He reduced his holdings of Treasuries for a third consecutive month to the lowest level since last October.
S&P last week cut Spain’s debt rating to BBB-, the lowest investment grade, and placed it on negative outlook.
Almost all sovereigns with poor debt dynamics are going to get downgraded, we’re just talking about the pace, Mather said. Credit rating companies "have been slow in downgrading some sovereigns, but we think the pace probably picks up in the year ahead.
Bond investors needn’t worry that a rating cut will hurt returns. About half the time, government bond yields move in the opposite direction suggested by new ratings, according to data compiled by Bloomberg on 314 upgrades, downgrades and outlook changes going back to 1974.
Sheila McKinney
