Downgrade Pushes Investors Into Safe Haven: U.S. Treasuries

FOXBusiness

Despite the historic downgrade Friday night by Standard & Poors, U.S. Treasuries are proving to be -- by far -- the most attractive investment out there on another volatile day in the global markets.

And no one is very surprised.

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People are pouring money into Treasuries, said Peter Cardillo, chief market economist at Rockwell Global Capital in New York. It shows that people do not believe that the U.S. is no longer credit worthy.

With the U.S. stock markets taking a beating (the Dow Jones Industrial Average was down more than 300 points in midday trading) investors are seeking safe havens. And theyre socking money where they always do during scary, turbulent times -- into U.S. Treasuries.

The yield on the benchmark 10-year note fell to its lowest level in nearly a year. The yield on the two-year note hit a new record low of 0.232%, putting it below the high end of the Federal Reserves zero to 0.25% range on its key overnight lending rate.

This after an historic downgrade of America' credit rating.

Cardillo suggested that investors have put the downgrade into perspective. The move had been expected for weeks, and, while symbolically important, the reality is that Treasuries were lowered just a single notch from AAA to double AA-plus.

Standard & Poors seemed to be issuing a warning, according to Cardillo, not necessarily casting suspicion on the ability of the U.S. to pay its debts.

Ironically, where the downgrade is causing the most havoc is in the stock markets, where fear and uncertainty over myriad economic issues has led to a wave of selling in the past two weeks. S&Ps downgrade Friday night has exacerbated that uncertainty.

Its causing a lot of havoc in the equity markets, said Cardillo.

But that fear and uncertainty is also contributing to the migration of money into Treasuries. Investors, fearful that the U.S. economy has stagnated and that no one in Washington has any answers, are rushing out of stocks and into Treasuries.

Much of this paradox had been predicted in recent weeks as the threat of a downgrade crystallized.

The big three ratings firms S&P, Moodys Investor Services and Fitch predicated their downgrade warnings earlier this year on the growing likelihood that the U.S. might default on its massive debt if nothing is done to rein in U.S. budget deficits.

Even after Congress voted to approve a budget deal last week that raised the U.S. debt limit and staved off an imminent default, the deficit-cutting aspect of the plan was widely panned as less-than-adequate. Congress plan cuts $2.4 trillion in spending over 10 years, whereas S&P had said $4 trillion was a starting point.

The threat of a downgrade remained on the table.

Meanwhile, Spain and Italy were dragged into the European debt crisis, with far larger implications because their respective economies are much bigger than those of Portugal or Greece, which have struggled for months to cover their debts.

The problems in Europe added to the fear and uncertainty prevalent in global markets. But at the same time Europes escalating problems held up in stark relief the point that U.S. debt is still far safer than most other forms of debt.

Consequently, the fear and uncertainty exacerbated by the S&P downgrade, which came at the tail end of one of the most turbulent trading weeks since the darkest days of the recent financial crisis, served only to make U.S. Treasuries that much more attractive.

Leonard Lardaro, an economics professor at the University of Rhode Island, predicted this scenario a week ago.

Despite all the turmoil in Washington and Congresss seeming inability to get its fiscal house in order, Lardaro asked, Is the U.S. less credit-worthy than either France or Canada? I think were as credit worthy if not more so.

Lardaros counterintuitive view of a downgrade has come to fruition. As he predicted, the U.S. downgrade has rocked global markets with the unintended consequence of increasing the role of U.S. Treasuries as a safe haven.

It wouldnt be that were beautiful, but we would be less ugly than some of the other alternatives, he said presciently.

The flow of cash into Treasuries grew even more pronounced Monday morning when S&P slashed its ratings on several issues of debt with close ties to the federal government, namely bonds from mortgage giants Fannie Mae and Freddie Mac.

Suddenly, mortgage-backed securities grew much riskier and investors pulled money out of them and moved it into Treasuries.

Cardillo said the run in Treasuries will last only as long as investors remain frightened by stocks, which shouldnt be long. We should see capitulation in the stock markets any time now, he said.

Still, the downgrade and its attendant ripple effects will mean far more attention will be focused on Tuesdays meeting of the Federal Reserves Open Market than might have otherwise.

Risk aversion is bad for a struggling economy: companies need investments, businesses need loans, and consumers need to feel confident about spending. Absent all of that, the Fed may consider more stimulus, regardless of how controversial that may be.

At the very least, the Fed will likely have to keep interest rates at their current low levels for longer than they probably had wanted.