Monday, August 08, 2011

Illogical Markets

We now see the first effects of the S&P credit downgrade on the markets. It seems that the main effects, apart from a big rally in gold and sell-off in oil, is that the stock markets falls and Treasury bonds rally (causing yields to drop).

This really makes no sense at all. If you care about what credit rating institutes thinks (I don't think you should, but clearly many people do) then the only effect should be to make U.S. treasuries less attractive relative to other assets because they are now viewed as more risky, something that in turn should raise Treasury yields.

I know of course that the reason Treasury yields have fallen is because the stock market has sold off, and that this could overwhelm the increased risk premium. But since the rating was about Treasuries and not the cyclical outlook for the U.S. economy or the riskiness of stocks, there is by contrast really no reason for the stock market to sell off, and therefore definitely no reason for Treasuries to rally.

This is like car customers reacting to news that one particular dealer defrauds and rips off his customers by shunning other dealers and instead buying more cars from the particular dealer who were shown to be fraudulent.

So apart from the gold rally, today's market movements are completely irrational, except perhaps to the extent they were reacting to other news.


Blogger krs said...

Here's an interesting view on bonds post-downgrade:

5:32 PM  
Blogger happyjuggler0 said...

The reason the official ratings agencies exist is because there are companies (life insurance companies for example) that are required by law to maintain assets with a minimum average rating.

When the top rated debt of the US gets downgraded, the average rating of the debt portfolios of these companies falls. Therefore they need to raise their average rating to stay in compliance with their regulators. Therefore they have to sell some of the lower rated debt instruments that they own, and buy some higher rated debt.

Hence the downgrade of US debt actually increased its demand amongst those who are forced to use the official ratings.

Perverse, isn't it?

7:15 PM  
Blogger traumerei said...

Considering that Greenspan pointed out that they will run the presses if need be, it seems that investors are reacting to general malaise in the stock markets. The Asian markets were down and the DAX was down 5% so reducing risk by buying "risk-free (lol)" Treasurys is a kind of knee-jerk reaction.

The only sure bet I had going in was gold - which responded as expected.

8:29 PM  

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