Economic Outlook: A downgrade, please

What you wouldn't wish on your enemies is for Standard & Poor's to downgrade their credit rating.

Essentially, the strategy might backfire.

S&P has been taking the first step in dire pronouncements lately. In August, it was the first major Western credit rating agency in history to lower the U.S. rating, scratching off its pristine triple A rating and replacing it with a slightly more humble AA+.

That move in early August triggered the most volatile week in the history of the Dow Jones industrial average. From Monday through Thursday, after S&P announced the new rating late on the previous Friday, the index moved up or down by 400 points in four consecutive trading days. It was the first time it had ever done that.

While equities rattled, however, yields on U.S. benchmark 10-year bonds dropped that week.

Investors simply had no place else to turn. Consequently, yields on benchmark notes began the week of Aug. 1 yielding 2.802 percent and closed out the week yielding 2.565 percent.

Six months later, yields on benchmark U.S. treasury notes stand at 1.867 percent. The government might well be asking why didn't S&P downgrade their rating sooner. Talk about the opposite of a self-fulfilling prophesy.

S&P pulled the same stunt after markets closed Friday, dropping France off its triple A perch and notching down credit ratings for Austria, Italy, Spain, Portugal, Malta, Cyprus, Slovakia and Slovenia.

Ouch. That has to hurt. Analysts quickly surmised that the blow dealt to France could have lasting political repercussions, since handling the economy in Europe has been French President Nicholas Sarkozy's primary focus for nearly two years. A credit rating downgrade is as clear a vote of no confidence as the financial world could dole out.

Well, not so fast. As it happens, the European Commission's rescue fund for struggling European countries, the European Financial Stability Fund, went online on Monday, the day after S&P landed all those assessment body-blows. And demand at a six-month debt sale pushed yields to an average of 0.2664 percent. Not bad for a day in which confidence was supposedly trounced.

Investors say a more solid test of confidence will come Thursday, when France attempts an auction of $12 billion in medium- and long-term bonds. However, "It is doubtful though that the downgrading of sovereign debt … will have more than a passing influence on bond yields and stress in bank funding markets," Mike Lenhoff, chief strategist at the financial planning firm Brewin Dolphin, told Britain's Daily Telegraph.

Why is that? Two reasons. For one, investors in Europe will follow the same dynamics that occurred in the United States. If equity markets look shaky, due to a downgrade of a country's government, then investors will turn to treasury notes, which are always a safer bet. As one analyst put it this summer, a particular corporation may or may not even exist 10 years down the road, but the U.S. Treasury is here to stay. Therefore, betting on the Treasury -- essentially betting on future U.S. taxpayers -- is always safer.

Secondly, it seems odd to put it this way, but who cares what Standard & Poor's thinks?

This has nothing to do with the agency getting it wrong or right. It has to do with market value, which S&P does not set. In terms of value, a credit rating agency can tell investors the color green is the color blue, but that doesn't make it so. It's not that investors are defiant -- they most certainly react to news from credit rating agencies. A rating shift can change government costs enormously. But markets still seek their own level regardless of one agency's opinion. And, of course, bad means good on Wall Street because savvy investors translate the word "bad" into the word "bargains," not run for the hills.

In international markets Tuesday, the Nikkei 225 index in Japan added 1.05 percent, while the Shanghai composite index in China surged 4.18 percent. The Hang Seng index in Hong Kong rose 3.24 percent, while the Sensex in India climbed 1.71 percent.

In Australia, the S&P/ASX 200 gained 1.65 percent.

In midday trading in Europe, the FTSE 100 index rose 0.57 percent, while the DAX 30 in Germany added 1.47 percent. The CAC 40 in France rose 0.94 percent, while the Stoxx Europe 600 gained 0.6 percent.
ANTHONY HALL || United Press International