Making one head(s) spin: the US credit rating
Rocky penned the following brain-teaser for the pages of an august publication — and wants to share it with his loyal readers…as it highlights an important market foible:
“I’m sure that we’ve both noticed that whenever Moody’s or S&P release a bearish
press release about the sovereign AAA rating, the stock market gets whacked by
1+%, but the US bond market hardly moves (or even rallies). One can explain the
downward move in stocks by observing that “in times of uncertainty, people
reduce their risk and seek the safety of riskless investments.” But is this
rational? Here, the increased uncertainty is arising from the RISKLESS asset.
So, if the riskless asset is becoming more risky, must it follow that the risky
assets are proportionately more risky? That is, if you sell the risky asset
because you’re scared of the riskless asset, does it follow that you should buy
more of the riskless asset even though it’s becoming more risky, and that’s
what made you sell the risky asset to begin with?
[Disclosure: Rocky expects that if Congress raises the debt limit without substantial spending cuts, bond yields will rise sharply....]