For so long that the USD and US Treasuries are accorded with “highly-liquid status”, any downward rating migration is unlikely to drive investors away. Moody’s had last Friday (10 November 2023) revised its outlook on the US sovereign credit rating to negative while reaffirming “Aaa” rating, citing large fiscal deficits, weakening debt affordability and more polarised political landscape. For the record, this is not new as Standard & Poor’s downgraded the rating more than a decade ago and so did Fitch months ago (See our Thematic Report published on 3 August 2023: The Downgrade of the US Long-Term Rating from ‘AAA’ to ‘AA+’ by Fitch- It makes 2 out of 3 for now). While this is fundamentally justified, we do not see this as a game changer for the market as eventually it budges down to liquidity. Liquidity remains the most important piece of puzzle among the investing community and the USD clearly carries the status as the most liquid currency in the universe at least until now. Whether it changes going forward depends on how fast other alternative currencies can rise to the occasion. Putting this case into perspective, a report by the Bank of International Settlement (BIS)1 in December 2022 revealed that average turnover per day with USD on one side of the transactions was USD6.6 trillion and the USD was involved in nearly 90% of global FX transactions. The USD’s dominance can be attributed to factors such the currency being use as a vehicle currency for FX transactions, USD as the main currency in offshore funding markets and the dollar’s significance in international trade settlements despite the United States accounts for only about 12% of global trade pie. The area where USD is losing some influence is its proportion in global international reserves but even so, the allocation is still more than 55% (Exhibit 2).

Treasury yields to remain dictated by monetary policy, but credit related events (debt-ceiling and budget stand-off episodes) become more frequent, causing knee-jerk reactions along the line. Fiscal related saga is not an abnormal factor, but the high-profile episodes have become more frequent in recent years with debt ceiling conundrums of 2011, 2013 and 2023 as cases in point. The disconnect between sovereign credit measures and America’s top-notch ratings has been growing over the years hence the sustainability of America’s debt levels is not a fresh issue. Changes in the political landscape where it is getting more polarised within the US Congress these days are contributing to more scrutiny, perhaps the new normal. If this situation transpires elsewhere other than the United States, we are most likely to see skyrocketing bond yields and widening credit default swap spread. Nonetheless, on this land, such a scenario is being prevented by virtue of USD liquidity as we argued earlier rather than credit risk factors. Until then, we opine that US Treasury yields will continue to be a strong function of monetary policy guidance by the US Federal Reserve.

Source: AmInvest Research - 14 Nov 2023