As credit raters move closer to downgrading U.S. debt, some investing pros are seeking safety.
With the credit agencies threatening to downgrade the U.S. government's debt, bond investors are considering the once-unthinkable: an investing environment where the safe bet may no longer be so safe.
While few believe the U.S. will stop making payments to its debt holders, the unprecedented move by credit ratings agencies Moody's Investors Services and Standard & Poor's to even consider a downgrade is significant for fixed-income investors, experts say. And the move comes at a time when U.S. investors are holding more government bonds than in the past. Investors poured $1.5 billion into government-bond funds in June, up from $150 million in May, according to Morningstar. Other types of bond funds have also increased their stakes in Treasurys as they've become a bigger part of bond indexes. For example, Treasurys now make up nearly 33% of the Barclays Capital U.S. Aggregate Bond Index, up from 24% four years ago and their highest level since the 1990s, thanks largely to U.S. government's increased borrowing.
What would a downgrade mean for investors? Because such a move would call into question the safety of U.S. Treasurys, typically considered credit-risk free because of the U.S.'s AAA ratings, it could impact everything from bonds to stocks to currencies since "everything is priced off of Treasurys," says Thomas Higgins, a global macro strategist for Standish. John Lonski, a chief economist at Moody's, predicts a downgrade could cause a "jarring market selloff" in stocks and bonds that could lead to losses in portfolios. Since Treasurys are paid in U.S. dollars, the dollar would likely depreciate as investors begin to value Treasurys less. Even relatively safe money market funds could lose value and hurt investors, since they invest heavily in Treasurys.
Of course, many experts expect Democrats and Republicans to reach an agreement to raise the debt ceiling by the Aug. 2 deadline -- an action that would likely prevent a downgrade and more serious market upheaval. As a result, some pros like Higgins say Treasurys may actually rally in the near future if it becomes clear that the U.S. can pay its debts. Higgins has been increasing his exposure to Treasurys. "Where else are you going to put your money? Japan? Europe? The situation doesn't look much better there," says Higgins.
But with so much uncertainty heading into the August deadline, many pros aren't taking any chances. Daniel Genter, chief investment officer of RNC Genter Capital Management, is sticking to high quality municipal and corporate bonds instead of riskier high yield bonds. Others recommend limiting exposure to the bond and stocks markets altogether by moving to cash -- at least for the near term. "If you don't have a strong stomach for volatility, this might be a good time to stay on the sidelines and wait till these matters play out," says Lonski.
Of course, many experts expect Democrats and Republicans to reach an agreement to raise the debt ceiling by the Aug. 2 deadline -- an action that would likely prevent a downgrade and more serious market upheaval. As a result, some pros like Higgins say Treasurys may actually rally in the near future if it becomes clear that the U.S. can pay its debts. Higgins has been increasing his exposure to Treasurys. "Where else are you going to put your money? Japan? Europe? The situation doesn't look much better there," says Higgins.
But with so much uncertainty heading into the August deadline, many pros aren't taking any chances. Daniel Genter, chief investment officer of RNC Genter Capital Management, is sticking to high quality municipal and corporate bonds instead of riskier high yield bonds. Others recommend limiting exposure to the bond and stocks markets altogether by moving to cash -- at least for the near term. "If you don't have a strong stomach for volatility, this might be a good time to stay on the sidelines and wait till these matters play out," says Lonski.
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