Friday, August 12, 2011

Lower Credit Rating = Lower Borrowing Rate?

After S&P lowered the credit rating of the United States from AAA to AA+, I posted that I agreed with the counter intuitive theory that the US Government bond rate would drop, rather than rise.  This is counter intuitive because individuals, business, and governments with a lower credit rating generally have to borrow at higher rates because lenders see them as a higher credit risk.  Consider your own life:  if you have a high credit score, you usually have access to lenders' best rates.  On the other hand, if your credit score is "less than perfect", you usually must pay a higher rate of interest when you take out a loan.

However, if you are the United States, you live in a bizzaro world where you can borrow at a lower rate of interest when your credit score drops.  According to this, the 10 year Treasury rate (i.e. the rate of interest the US gets when taking out a ten year loan) started off the week at 2.5%.  However, on Friday, the 10 year rate had dropped to around 2.2%.  Why did this happen?  The most likely theory is that most people took this as a sign of uncertainty.  Therefore, they decided to move their money to the safest investment that they could think of:  US Treasury Bonds.  Meanwhile, although the stock market generally ended the week where it started, the week was filled with enough ups and downs to satisfy any roller coaster enthusiast.

This behavior is typical.  Uncertainty causes people to sell stocks (generally viewed as risky) and buy bonds (generally viewed as less safer).  However, in the context of the lower credit rating for Government Bonds, it does seem incongruous.

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