Impact of the potential ratings downgrade

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A week ago, Standard & Poor’s (known as S&P) downgraded the U.S. credit rating to a negative. The U.S. did not loses its AAA rating, but the downgrade makes it increasingly likely it could occur if government doesn’t get deficit spending under control.

Does the downgrade mean good news for interest rates? Bad economic news is typically good news for mortgage rates. The initial market reaction to the S&P decision would back this up as stocks took a dive, and bonds barely moved on the announcement.

What does this mean in the long term if the U.S. loses its AAA rating? Easy answer – losing the AAA rating would negatively impact everyone.

The damage to stocks is obvious… losing the AAA rating is bad for business. Bad for business = bad for the economy. When the economy drags, stocks tend to follow (as evidenced over the last couple of years).

Combating a downgraded rating would also hurt interest rates. If you read the previously linked Wall Street Journal article, possible scenarios could include:

  • the U.S. not defaulting, but becomes more difficult to borrow money
  • an option to pay off debt could include printing more money/lowering the value of the U.S. Dollar

Both of those options for dealing with deficit spending and a rating downgrade hurt interest rates. The U.S. would still find funding sources, but not at the favorable rates we see today. An increase in the rates for the U.S. to borrow money would cause all rates to increase.

Second, printing more money leads to inflation. There is no way around it. Bonds HATE inflation. The higher the rate of inflation goes, the faster bonds lose their value. As we all know from reading this blog, as the value of bonds go down, interest rates go up!

Losing the AAA rating would be bad for everyone… the government, investors, stock prices, bond prices, retirees, home buyers… you name it, and it will probably be impacted. This is one thing that both sides in Washington agree on – we don’t want to lose the AAA rating. Now, let’s see if they can agree on a way to prevent a potential ratings downgrade!

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