If U.S. Treasuries were downgraded, fixed-income portfolio managers may be forced to sell off lower-rated debt, strategists at DB Advisors, Deutsche Bank's institutional investment management unit, said Tuesday in a conference call.
“The corporate market is fairly insulated” from a possible Treasury default and potential downgrading, Stephen Johnson, DB Advisors' U.S. chief investment officer, said.
There is generally not a direct linkage with corporate and Treasury debt, Mr. Johnson added.
However, in the event of a Treasury downgrade, investors' fixed-income portfolios might find their overall credit quality lowered, Mr. Johnson said. To the extent investors have to maintain a certain average portfolio credit quality, they might sell lower quality securities and buy higher quality issues to raise their portfolio's overall credit quality, Mr. Johnson added. Such a move would lead to a less diversified, more concentrated portfolio, considering there are only four AAA rated and 30 AA rated corporate bonds, he said (see related chart).
Investors really have no alternatives to Treasury securities, Joshua N. Feinman, chief global economist, said in the conference call.
But with limited, diversified options, the likely alternative for investors would be to lower their portfolio quality to the level of Treasury securities, Mr. Feinman said, adding that action might require revising investment policy guidelines.
A Treasury securities downgrading would not cause investors to engage in a huge reassessment of dollar-denominated assets, Mr. Johnson said.
The federal government has an extremely low probability of default but market reaction to any credit-rating downgrading of Treasury debt likely would raise its long-term yields 20 basis points to 30 basis points, according to Mr. Feinman and Mr. Johnson.
“At the end of the day … I think everyone is reasonably confident with the creditworthiness of the U.S. and I would expect no huge reaction in the market,” Mr. Johnson said.
“This (Treasury securities) still is the most liquid market in the world and tends to be the place people trade into when they are worried about any financial problems in the world,” said Mr. Feinman. “I see this (continuing) as the normal safe haven, even with (a) downgrading. I don't see the Treasuries losing that status.”
“I'm not terribly concerned (about) a downgrading to a high AA rating,” if it would occur, Mr. Feinman added.
Even if an agreement isn't reached between Capitol Hill and the Obama administration on the debt ceiling by Aug 2, “there is an extremely low probability of default,” Mr. Johnson said in an interview after the conference call. That date is when the federal government risks not having enough revenue to pay Treasury security holders and other federal outlays
“They (Treasury) would prioritize the interest payments,” Mr. Feinman said.
“We would argue you shouldn't” have concerns about Treasury debt, Mr. Feinman added.