August 8: Sizing Up the Downgrade’s Impact – Economic Highlights

Standard & Poor’s came through on its threat after all, downgrading the U.S. from tripple-A to double-A-plus. While this headline-grabbing news comes at a particularly bad time for markets, it was hardly a surprise. The action had become all but inevitable after last weekend’s debt deal included fewer deficit-reduction measures than the rating agency had asked for.

The downgrade will further unsettle markets that had started fretting about the U.S. economy’s growth prospects in recent days. Last week was one of the worst for stocks since late 2008 as fears of a fresh recession started taking hold. I don’t think those fears are warranted, but last week’s negative momentum will get further support from S&P’s rating action.

Beyond stocks, the action will likely do little to diminish the ‘safe-haven status’ of U.S. Treasuries, where yields have been on a downtrend despite this expected rating move. The bond markets had effectively discounted this action already and are unlikely to show any negative reaction today. It will, however, give further boost to gold and other precious metals.

The downgrade’s impact on other major commodities, such as oil and copper, will depend on the impact the action will have on the exchange value of the U.S. dollar relative to other major currencies. The initial impact will likely be negative. But irrespective of how these commodities trade today, their trading behavior in the coming days will reflect the growth outlook for the U.S. and global economy. And on that front, the rating downgrade will have little, if any, enduring impact.

Overall, I don’t think the rating downgrade is a big deal. It was well telegraphed ahead of time and many of us had started suspecting some element of selfish motives on the part of the rating agency as well. Afterall, the S&P and its peers had been found sleeping at the switch as the sub-prime crisis took hold.

But irrespective of the rating agency’s motives, the U.S.’s credit profile is no better or worse today than it was last week. The downgrade just adds another headline-grabbing negative element to a host of things that the markets were already grappling with.