The U.S.’s sovereign credit rating will be cut as “fiscal theater” plays out in the world’s biggest economy, according to Pacific Investment Management Co., which runs the world’s biggest bond fund.
“The U.S. will get downgraded, it’s a question of when,” Scott Mather, Pimco’s head of global portfolio management, said at a briefing in Wellington, New Zealand. “It depends on what the end of the year looks like, but it could be fairly soon after that.”
The Congressional Budget Office has warned the U.S. economy will fall into recession if $600 billion of government spending cuts and tax increases occur at the start of 2013. Financial markets are complacent about whether the White House and Congress will reach agreement on deferring the so-called fiscal drag on the economy until later next year, Mather said.
Editor's Note: The ‘Unthinkable’ Could Happen — Wall Street Journal. Prepare for Meltdown
In a “base case” of Barack Obama being re-elected and Congress becoming more Republican, there is a high likelihood an agreement “doesn’t happen in a nice way, and we have disruption in the marketplace,” he said.
Policy makers probably will agree on cutbacks that would lower economic growth by about 1.5 percentage points next year, Mather said. They may roil markets by discussing scenarios that would lead to a 4.5 percentage-point fiscal drag, he said.
Standard & Poor’s cut the U.S. credit rating to AA+ from AAA on Aug. 5, 2011. Since that time, benchmark Treasury yields have dropped to record lows.
CDS Dropping
Credit-default swaps tied to U.S. debt, which typically fall as investors’ perceptions of creditworthiness rise and increase as they deteriorate, have dropped to 31.4 basis points from 55.4 basis points on the day of S&P’s downgrade and a record 100 in February 2009, according to data provider CMA. The firm is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market.
S&P last week cut Spain’s debt rating to BBB-, the lowest investment grade, and placed it on negative outlook.
“Almost all sovereigns with poor debt dynamics are going to get downgraded, we’re just talking about the pace,” Mather said. Credit rating companies “have been slow in downgrading some sovereigns, but we think the pace probably picks up in the year ahead.”
Pimco forecasts global growth of 1.75 percent in the year through September 2013, weighed down by a eurozone recession and a slowing pace of expansion in China.
‘Dismal Outlook’
“It’s a pretty dismal world growth outlook,” Mather said, adding that it will be difficult to return to former levels of growth in many of the world’s biggest economies because of the levels of debt, structural changes in the labor market and slower growth in the working age population.
Those changes mean that a 2 percent expansion in the U.S. may in the future be seen as good growth, not the 3 percent that investors have been used to, he said.
It is difficult to see China’s growth continuing at a 7 percent pace, considering demographic changes and the challenge of maintaining expansion as the economy moves to a domestic consumption model from one based on exports, he said.
China’s economy probably expanded 7.4 percent in the three months ended Sept. 30 from a year earlier, slowing for a seventh quarter, according to the median estimate in a Bloomberg News survey of economists.
Editor's Note: The ‘Unthinkable’ Could Happen — Wall Street Journal. Prepare for Meltdown
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