US debt remains investor safe haven despite S&P downgrade

The US Treasury Department in Washington, DC
© AFP/File Mladen Antonov

PARIS (AFP) – US Treasury bonds remain a hot ticket for investors looking for a low risk investment in a volatile market despite the unprecedented downgrade of Washington’s credit rating, analysts say.

The decision by Standard & Poor’s to strip Washington of its top triple-A rating has done little to diminish investors’ appetite for US Treasuries, which along with gold, the Swiss franc and the yen are considered among the safest of assets.

At first it may seem somewhat paradoxical, but with investors concerned about a slowdown in the global economy, they are piling into US bonds which are also attractive because of the dollar’s reserve currency status.

On Monday, the first trading day after the the S&P downgrade, US bond prices rose to record levels on strong demand in a fresh issue, with the rate of return for investors dropping from before the US lost its top rating.

On the secondary market the yield on 10-year securities dropped on Wednesday to 2.09 percent, the lowest rate since December 2008 and down from 2.56 percent on Friday, before the S&P announcement.

“We do not regard the Standard & Poor’s downgrade as an immediate threat to Treasuries keeping their safe-harbour status,” market analysts Briefing Research said.

“Treasuries are still the gold standard, so much so that as the US veered toward a default [during negotiations to raise its debt ceiling] Treasuries rallied on a flight-to-safety … as if they were being rewarded for a crime”, the group said.

The gyrations on global stock exchanges this past week have only increased their attraction.

“The US Treasury market will remain by far the largest and most liquid in the world, with no equal, and a relative safe haven in times of global financial stress — as demonstrated by in last week’s global financial turmoil and ‘wholesale flight to safety and quality’,” said Nigel Gault from market forecasters IHS Global Insight.

Few assets can claim this role: among them are gold, which this week surged and set a new record above $1,800 an ounce, and certain currencies including the Swiss franc and the yen which have also been riding high.

A rush of safe-haven money into the franc led to fresh records against the dollar and the euro, forcing the Swiss National Bank to take additional measures to stem its rise which is hurting the country’s industry.

The Federal Reserve’s decision on Tuesday to maintain interest rates at close to zero levels for two years also reassured markets, said Aurel BGC.

Analysts said meanwhile that China, the world’s largest foreign holder of US debt, has no choice but to maintain its Treasury holdings, with Beijing’s hands tied for several reasons in the short run.

China has the world’s largest foreign exchange reserves at more than $3 trillion, and experts believe it would be difficult for it to find alternative investment options able to absorb such volume.

With around $1.2 trillion in US Treasuries, Beijing also cannot conduct large-scale selling of dollar assets without diminishing the value of its remaining holdings, they said.

“It is very difficult to cut the holdings of US Treasuries. With such huge foreign exchange reserves, if you don’t invest in US debt, it is hardly possible to diversify them,” said Liu Hongke, economist at CCB International Securities.

“Despite the downgrade (in the US credit rating), the United States is still safer than Europe,” Liu added.

The European Central Bank stepped in to buy Italian and Spanish debt as investors had driven their bond yields to unsustainable levels on concerns that they might be next eurozone members to become ensnared in a debt crisis.

“Unlike a spurned romantic partner, many investors have nowhere to turn for notionally low risk, highly liquid investment options,” said Nicholas Colas from ConvergEx.

“If you need to park large amounts of capital, the US sovereign debt market is still the only garage that can accommodate the tractor-trailers of cash generated by large oil producing countries or major exporting nations,” he added.