The world’s largest asset manager, BlackRock, has moved to reassure markets following Standard & Poor’s US ratings downgrade, confirming it will not be foreseller of US Treasuries and saying its portfolio rebalancing will be negligible.
Peter Fisher, the firm’s global chief investment officer for fixed income, was speaking to AsianInvestor from New York as markets were just opening across Asia-Pacific.
By close last night all Asian stock markets finished in the red bar Pakistan and Sri Lanka. The declines were led by Kospi and Taiex which both sank 3.83%, followed by CSI 300 (-3.57%), and Singapore’s FTSE Straits Times Index (-3.44%). Nikkei and Hang Seng fell about 2.2%.
In a phone interview, Fisher notes that only about 100 Blackrock portfolios were affected, which the $3.66 trillion global asset manager rounds to zero in terms of its overall universe.
“We have dealt with a few portfolios where there might have been an issue and revised the guidelines and talked to the clients,” he says. “But there are very few investors in the world who as a consequence of this downgrade are compelled by their discipline to buy and sell any asset.
“We are not going to be foresellers of anything and we are not mechanistically responding to S&P’s action. We will be managing risk in our portfolios and looking for opportunities that are out there.”
Evidently the subject of a US downgrade is an emotive one for Fisher, who from 2001 to 2003 served as undersecretary of the US Treasury for domestic finance.
After all, Bank of America Merrill Lynch starkly points out that there are now 18 countries and seven global corporations with a better credit rating than that of the US government.
Asked if he felt S&P’s downgrade was merited, Fisher replies: “It is pretty upsetting to contemplate.”
He notes that the US could have been downgraded five years ago or two years ago based on the long-run fiscal outlook with a view to economic forecasts on government spending and revenues.
“I don’t begrudge someone who wants to take that opinion, but the logic S&P offered surprised me a little about how short-run and very focused on near-term politics it was,” he states.
“It was not based on long-run, 75-year actuarial present value of assets and revenues and outlays. It was based on the short-term political mix, which isn’t really about the ability of the US government and its willingness to pay its debt.
“I think the US is still likely to be an economy I would bet on against the rest of the world and I think the ability and willingness of the US people to pay their obligations over the next 50 years are as good as any. On the long-run fiscal outlook you could choose to downgrade them if you wanted to. I would not begrudge you that, but it would not be my call.”
Fisher says that with markets already jittery over the European debt crisis and US economic weakness, investors are more likely to dump equities and other risk assets before US Treasuries, as evidenced by yesterday’s stock market performances around Asia and over the past few weeks.
Further, he does not believe there will be a rebalancing out of US Treasuries over the longer term as a reflection of fiscal realities.
“Working your way through a big debt problem in a country usually slows down growth, and when you slow down growth people want to hold the least risky asset. That is the irony we have to deal with,” he argues.
“A lot of people have thrown around this idea that the downgrade is likely to lead to a 25 basis point risk premium. I am not sure that happens with just one ratings agency. I think if all the ratings agencies downgraded the US you might see a credit risk premium as big as that creep in.
“If you ask me about aggregate demand for US Treasuries, the world is a risky place and there is going to be a bid for them. If growth is slow, there will be a higher US household savings rate and higher demand [for US Treasuries] from that source.”
But Fisher is not anticipating a US downgrade from either Moody’s or Fitch in the next few months as they wait to see the outcome of legislation Congress has enacted.
“My best guess is they would wait and see till the end of the year when there will be a whole new set of facts we will all have about how Congress may have reacted and how significant the spending cuts may be and frankly whether there will be revenues raised on top of that.”
In a separate statement, Blackrock notes it is prepared for continued downgrades of many other issuers and issues that derive their rating from the US government rating – including government sponsored enterprises (GSEs) and some corporate.
But it stresses that the US Treasury sector, and to a lesser extent agency-backed mortgage-backed securities, remains the world’s largest and most liquid fixed income market with the greatest degree of price transparency and few genuine alternatives.
“Treasuries will continue to see a strong bid from institutional investors of all kinds (including banks) and will continue to serve their traditional role as a hedge to risk assets,” it says.
“While a time may come when the credit risk-free status of Treasury bonds is diminished by continued policy missteps, we do not believe the S&P downgrade signals that this moment has come now.”
Separately, Northern Trust also says the downgrade of US Treasury debt will not affect the firm’s view of the US bond market and that it has no plans to sell US Treasuries as a result.
Its chief investment officer, Bob Browne, notes that with regard to money market funds, the short-term ratings of the US remain unchanged by S&P at A1+, the highest level.
He also believes the fact that the US Federal Reserve has said S&P’s decision will not affect US banks’ risk-based capital requirements for US Treasuries should address market concerns.
But the fixed income desk at Manulife Asset Management believes the rating downgrade has the potential to hasten the diversification away from the US dollar and US Treasury Securities already undertaken by global central banks.
“This reserve diversification will continue to be supportive for the currencies and bond markets of those Asia-Pacific countries with higher sovereign ratings (Australia, Singapore) as well as those countries on an upward sovereign rating path such as Indonesia and the Philippines.”
When it comes to emerging markets, Mark Mobius of Franklin Templeton remains an outspoken proponent. He points to the relative attractiveness of their currencies and stocks given the size of foreign reserves and debt-to-GDP ratios.
“This improved ability to manage their currencies and historically better ability to service debt is why we believe emerging market currencies have been so strong – and may continue to be,” he says.
As an institution, Franklin Templeton anticipates that other ratings agencies will eventually follow S&P’s lead.
Roger Bayston, the firm’s director of fixed income, is expecting to see some portfolio asset shifting in the market place as a result of the downgrade.
But he adds: “We do not anticipate global investors losing interest in the US during times when investment risk is being reduced, and we expect the US dollar to remain the reserve currency for most places around the world.”
Ed Jamieson, CIO of Franklin Equity Group – a growth style manager under Franklin Templeton Investments – is expecting market volatility and equity market declines in the short term. But he adds: “We do not believe the recent downturn in the stock market is indicative of a double-dip recession given numerous data indicate the US economy continues to expand.”
It was a point reiterated by Erik Ristuben, Russell Investments’ chief investment officer, who says recent negative market volatility reflects a drop in confidence in response to a spate of negative headlines – not a global economic collapse.
“Our analysis of the facts leads us to believe that although the economy has been weakened, a double-dip recession still remains unlikely,” he says.
“The downgrade does raise technical concerns regarding capital requirements for banking, insurance, derivatives and money funds, but the Fed, other regulators and governments in Europe and Asia have strongly stated that the risk weighting for US treasuries in capital structures remains unchanged.”
Meanwhile, Bank of America/Merrill Lynch argues the potential for a “tipping point” for the global economy and markets is great given the importance of the US Treasury to set the price for risk-free assets.
“In particular, we worry that any re-pricing of ‘risk-free’ US Treasuries would have a material knock-on effect to all other asset markets,” it says.
It advises investors to watch out for the success of US Treasury and sovereign debt auctions; the degree of redemptions from US money market funds; the ability of very cheap and very oversold global financial stocks to rally; and the resilience of the new safe havens of emerging market currencies and bonds.
It also expects S&P to downgrade the US a notch further to AA and for Fitch and Moody’s to do their first downgrades “if, as we expect, the recently created deficit commission does not come up with tax and entitlement reforms later this year”.
It argues that this latest shock presents another reason for the Fed to stay accommodative for longer, and forecasts that the first interest rate hike will not come before the first quarter in 2013.
But it does not expect emerging market central banks to rush to unwind their dollar holdings. “In the face of a weakening global economy, we expect foreign governments to continue to resist weakness in the dollar as part of their export-led growth strategy.”
BoA Merrill also points out that equities are cheap, with the MSCI ACWI trading at 10.9x forward earnings, and that oil prices have fallen sharply.
It lists buying catalysts as: Asian/EM currencies soar to punitive levels, prompting Asian/EM central banks to reverse tightening and cut rates; ECB to cut rates to address the wreckage in European markets; US policymakers to announce QE3; policy coordination in the form of a G20 FX policy to break the weak dollar/strong commodity psychology; investor capitulation in its August Fund Manager survey as evidenced by a jump in cash balances.