Friday, May 22, 2009

Bonds Hit by Ratings Fears

Standard & Poor's Warns U.K., Spurring Global Worries About Climbing Debt By STEPHEN FIDLER and NEIL SHAH Britain was warned by Standard & Poor's Ratings Service that it may lose its coveted triple-A credit rating, triggering a drop in U.K. bonds and sparking global fears about the consequences of massive debts being incurred by the U.S. and other major nations as they try to dig out from the economic crisis. S&P changed its outlook for the U.K.'s credit rating to negative, meaning a downgrade could come in the next couple of years. The warning -- marking the first time the U.K.'s top rating has come under threat since S&P began assessing it in 1978 -- is another blow for Prime Minister Gordon Brown ahead of elections to take place by June 2010. The announcement quickly sent waves across the Atlantic. Investors initially dumped U.K. bonds and the pound, heading for the relative safety of U.S. Treasurys. But within hours, worries about an onslaught of new U.S. bond sales and the security of America's own triple-A rating drove down the prices of U.S. Treasurys. Heard on the Street: U.K.'s Triple-A Challenge The yield of the benchmark U.S. 10-year bond, which moves in the opposite direction to the price, rose by 0.15 percentage point from Wednesday to 3.355%, its highest level in six months. The relative gloom about the U.K. and the U.S. was apparent Thursday in the market for credit-default swaps, where investors can buy and sell insurance against sovereign defaults. Five years of insurance on $10 million in U.K. debt jumped to around $81,000 a year, from $72,000 earlier in the day. U.S. debt insurance cost the equivalent of $37,500 -- in the same range as France at $38,000, and Germany at $35,000. The dollar, meanwhile, declined to its lowest level against the euro in more than four months, with the euro rising 1% to $1.3905. The dollar ended the day at a six-month low against the pound. The British currency traded up 0.37% at $1.5856. Britain's troubles reflect how countries' attempts to revive their economies and save shaky banks are taking a heavy toll on government finances. In recent months, both Ireland and Spain lost their triple-A ratings. In October, Iceland fell from single-A-plus to triple-B-plus. Analysts said S&P's warning to the U.K. is a worrisome signal for other nations that are seeing their debt loads grow to levels not seen since the aftermath of World War II. S&P expects the ratio of debt to gross domestic product to soar in many countries by 2013. In the U.S., it sees debt to GDP rising to 77%, from 44% last year; in Japan, to 120% from 110%; and in Italy, to 116% from 102%. Thursday's selloff in U.S. and U.K. government bonds highlights the risks the two countries face as they try to jump-start their economies. The two governments hope that all the money they are borrowing will spur so much growth that the debt will shrink as a portion of their economies. The risk is that growth will be weak, leaving the economies still struggling but with heavy debt loads. That's the argument made by other countries, notably Germany, that are taking a more conservative path, hoping their economies rebound without taking on that much debt. Fears that out-of-control spending will boost inflation are big reasons that both Germany and France have resisted boosting their stimulus spending further, and are likely to oppose any new attempt to get them to do more on that front. S&P sees debt ratios in France and Germany growing comparatively slowly -- to 69% and 72%, respectively. S&P's warning to the U.K. led some analysts to worry that the U.S. could be next, although the dollar's status as a reserve currency gives the U.S. much more ability to carry a heavy debt load. "It's the pace of deterioration in finances that is the driving factor here," said Huw Worthington of Barclays Capital. "The U.K. and the U.S. have fallen far and fast, while the decline in the likes of Germany and France are more measured." U.S. stocks fell for a third straight day, with the Dow Jones Industrial Average dropping 129.91 points, as poor jobless claims figures added to the worries about the U.S. economy. The threat to the triple-A rating of the U.S. has been debated for years, as spending surged and deficits ballooned. Yet ratings companies have never budged on their outlook for the debt and many analysts see a downgrade as highly unlikely. A spokesman for Moody's Investors Service reiterated the New York rating company's view that the U.S. debt rating is stable at triple-A. On May 6, Moody's noted in a credit opinion that, "While government financial strength is weakening as a result of interventions to support the financial system and the economy, other factors supporting the Aaa rating remain intact." A spokesman for S&P said the rating firm continually reviews its ratings and last affirmed the U.S. at triple-A with a stable outlook in mid-January. S&P has triple-A ratings on 18 sovereign debt issuers. U.K. stocks also plunged on Thursday, with the benchmark FTSE 100 index falling 2.7% to 4345.47 after S&P's warning. Prices of U.K. government bonds, or gilts, also fell, pushing their yields slightly higher and effectively raising the government's borrowing costs. The yield on the 10-year gilt jumped to 3.65% on Thursday from 3.58% the previous day. S&P said that it will revisit the U.K.'s rating after the elections next year. "This is a gun to the head of the next administration to get the public finances back in order," said Russell Silberston, head of global interest rates at Investec Asset Management in London. A downgrade would exacerbate the U.K.'s financial difficulties, including a gaping budget deficit, by making it more expensive for the government to borrow money, and would be a big comedown for a country that hasn't defaulted on its debt since 1693 and whose currency was at one time the preferred global medium of trade. S&P said the U.K.'s public debt is likely to nearly double to 97% of the country's annual economic output by 2013 -- a level that, if sustained, would be inconsistent with a triple-A rating and far exceeds the government's estimate of a 79% debt-to-GDP ratio by April 2014. S&P says the cost of the U.K.'s bank bailout could reach nearly three times the government's estimate of £50 billion ($78.76 billion). The opposition Conservative Party seized on the opportunity to criticize Mr. Brown's Labour Party. "It's now clear that Britain's economic reputation is on the line at the next general election," said George Osborne, the Conservatives' economic spokesman. The Conservatives, which stress fiscal responsibility in their platform, had a 16 percentage point lead over Labour in a survey by Internet-based polling firm YouGov published Monday. Stephen Timms, a Treasury minister, said that the government has set out plans to halve the deficit over the next four years and to bring the public finances back into balance in the medium term. "That's the discipline that's needed at the moment, and that's the discipline that we are delivering," he said. On Thursday, though, the government reported that its budget deficit had reached £7 billion in April, nearly 10 times the level of a year earlier, putting the U.K. public debt on track to exceed the government's forecasts. The U.K. Treasury on Thursday noted that S&P reaffirmed the country's triple-A rating, at least until after the election. Fitch Ratings and Moody's Investors Service Thursday said they have no plans to change their triple-A rating of U.K. government debt. "While the U.K. economy and public finances face considerable challenges, the government has both enough balance-sheet flexibility to absorb the shock in the short-term, and the capacity to reverse the damage over time," said Arnaud Mares, an analyst at Moody's. Moody's would change the U.K.'s rating only if it were convinced that the deterioration in Britain's finances was irreparable, Mr. Mares said. —Alistair MacDonald in London, Min Zeng in Washington and Serena Ng in New York contributed to this article. Write to Stephen Fidler at stephen.fidler@wsj.com and Neil Shah at neil.shah@dowjones.com

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