Bond vigilantes tend to be rude about rating agencies, and with good reason. But it is Standard & Poor’s, not the bond market, that is trying to get US politicians to treat the country’s fiscal deficit seriously.
Should anyone care that S&P has put US sovereign debt on negative credit outlook? The answer should plainly be “no”. This is only an opinion, based on public data, with a one-third chance that action will follow within two years. Given the scale of the deficit, it is obvious that rating agencies should at least consider downgrades, whatever they say in public. But this gesture is important precisely because it is aimed at politicians, not investors. S&P chose to surprise the market, and to move to a formal negative outlook when it could merely have mused publicly about downgrades, as Moody’s did earlier this year.
It could have raised the alarm about the debt ceiling, the current hot topic. Instead, it emphasised the risk that “US policymakers might not reach an agreement on how to address medium and long-term budgetary challenges by 2013”. In other words, if politicians try to avoid this issue until after the 2012 election, they will suffer a downgrade.
And the fact that Treasury yields fell after S&P’s announcement shows just why US politicians get away with their profligacy – if the rest of the world seems risky, there are still few alternatives to the US. Bond vigilantes do not scare politicians; S&P is at least trying.
Markets, meanwhile, are scared by the Federal Reserve. Austerity could have strange side effects. In the UK, tight fiscal policy has made it harder for the central bank to raise rates. The same might hold in the US. And by the same token, continued profligacy in Washington might force the Federal Reserve to start tightening earlier.
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