The global bond market disagreed with Moody's Investors Service and Standard & Poor's more often than not this year when the companies told investors that governments were becoming safer or more risky.
Yields on sovereign securities moved in the opposite direction from what ratings suggested in 53 percent of the 32 upgrades, downgrades and changes in credit outlook, according to data compiled by Bloomberg. That's worse than the longer-term average of 47 percent, based on more than 300 changes since 1974. This year, investors ignored 56 percent of Moody's rating and outlook changes and 50 percent of those by S&P.
For national debt, following decisions of the arbiters of credit risk is less reliable than flipping a coin for determining borrowing costs. While the companies face legal proceedings and more regulation after contributing to the worst financial calamity since the Great Depression, politicians cite the grades as one reason for austerity when Europe is in recession and the Federal Reserve has cut its growth forecast.
“Policy makers should be more preoccupied with the market than with the ratings companies, because that's where the real costs bear out,” Brett Wander, the chief investment officer for fixed income in San Francisco at Charles Schwab Investment Management Inc., which oversees about $200 billion, said in a telephone interview Dec. 14. “Credit-rating agencies historically lag the real economic fundamentals, whereas markets are ahead.”
Moody's, which helped start the business of ranking companies by their ability to repay debt in 1909, has downgraded 6.4 government ratings for every upgrade this year in the U.S. and Europe, the highest ratio since at least 2002, Bloomberg data show. S&P has cut 4.3 rankings for every increase.
Even so, European bonds are having their best year since 1998, returning 11.5 percent through Dec. 14, according to the Bank of America Merrill Lynch Euro Government Index. The best bonds in the world were Greek securities, which gained 84 percent, and Portuguese notes, up 55 percent, according to indexes compiled by the European Federation of Financial Analyst Societies.
Yields on all government securities declined to a record low 1.36 percent on Nov. 28, according to Bank of America Merrill Lynch index data going back to 1996. The bonds returned 4.5 percent this year.
“If ever there was proof positive that ratings were a lagging indicator, it's certainly been true with the way the rating agencies have responded to” Europe's three-year debt crisis, Bonnie Baha, the head of global developed credit at Los Angeles-based DoubleLine Capital LP, which oversees more than $50 billion, said Dec. 12 in a telephone interview. The gap between Treasury yields and those of other bonds is more reliable, she said.
The yield on the 10-year Treasury note decreased eight basis points last week to 1.70 percent, as negotiations stalled between President Barack Obama and House Speaker John Boehner to avert mandatory tax increases and spending cuts. The rate increased two basis points, or 0.02 percentage point, to 1.72 percent as of 9:12 a.m. in New York.
S&P and Moody's say they aren't predicting yields.
“Ratings are really just a rank ordering of our opinion of relative credit worthiness based on our criteria,” Peter Rigby, a credit analyst at S&P, the New York-based unit of McGraw-Hill Cos., said Aug. 16 in a telephone interview. “It's neither an objective nor goal or intent to determine yields or prices. Obviously, investors do that using a whole host of information and different investors have their different valuation objectives.”
Eduardo Barker, a spokesman for Moody's, declined to comment. Richard Cantor, the company's chief credit officer, said in May in an e-mail that “we have only one objective, which is to assign ratings that are indicative of the relative risk of default and losses.”
S&P, Moody's and Fitch Ratings, a unit of Paris-based Fimalac SA, provided more than 99 percent of rankings of government, municipal, and sovereign debt and 96 percent of all outstanding grades last year, according to a Nov. 15 U.S. Securities and Exchange Commission report.
One reason for the divergence between bond performance and ratings is that investors with the most at stake may act before Moody's and S&P.
“I don't agree that markets don't care about ratings,” Peter Palfrey, who helps oversee $182 billion at Loomis Sayles and Co. in Boston, said Dec. 11 in an interview. Changes are “largely priced into the market already.” Palfrey is a co- manager of the Natixis Loomis Sayles Core Plus Bond Fund (NEFRX), which has beaten 98 percent of its peers for the past five years, Bloomberg data show.
Central banks' buying unprecedented amounts of government securities to pump money into their financial systems and keep interest rates low is also driving the divergence between ratings and bond performance, according to Jason Brady, a managing director in Santa Fe, New Mexico, at Thornburg Investment Management, which oversees $83 billion.
The European Central Bank said it will buy bonds of Spain, which is rated one level above non-investment grade, and Italy if requested. The ECB has expanded its balance sheet by about 702 billion euros ($924 billion) since November 2011. Europe's economy is forecast to shrink 0.14 percent this year and to expand 0.4 percent in 2013, according to Bloomberg surveys.
In the U.S., the Fed will buy $85 billion a month of Treasuries and mortgage bonds starting next month after the Federal Open Market Committee reduced its growth forecast for next year to as little as 2.3 percent from as low as 2.5 percent. The central bank will absorb about 90 percent of net new dollar-denominated fixed-income assets next year, according to JPMorgan Chase & Co.
Even before the latest stimulus efforts, government securities were moving contrary to decisions by Moody's and S&P. Since the U.S and France were stripped of their top AAA rankings, their bonds surged.
Rates on 10-year French debt fell to 1.98 percent from 2.07 percent on Nov. 19 when it was cut by Moody's. Yields on similar-maturity Treasuries tumbled to a record low 1.379 percent in July from 2.56 percent on Aug. 5, 2011, just before the U.S. was downgraded by S&P.
After the Treasury Department said S&P made a $2 trillion error in its calculations, the company switched the budget projections it was using and proceeded with the downgrade. S&P denied it made a mistake and said using the government's preferred fiscal scenario didn't affect its decision.
While 67 percent of 1,031 global investors in a Bloomberg Global Poll in September 2011 said S&P's move was justified, Warren Buffett, the world's second-richest person according to Bloomberg Billionaires Indexes, said the U.S. should be “quadruple-A.” Buffett is Moody's biggest shareholder.
Rising borrowing has prompted downgrades. European government debt climbed to 90 percent of gross domestic product in the second quarter from 66 percent in December 2007, data from Luxembourg-based Eurostat show. That ratio in the U.S. is expected to increase to more than 70 percent by the end of 2012 from about 36 percent at the end of 2007, according to a Congressional Budget Office forecast.
Moody's said Sept. 11 it may follow S&P in removing the U.S.'s top rating unless politicians can contain the growing ratio of debt to GDP. Boehner, a Republican from Ohio, said the warning underscores his contention that rising debt is imperiling jobs.
France's downgrade was “strong encouragement,” to pursue austerity, Finance Minister Pierre Moscovici said Nov. 20 in an interview with Bloomberg Television's Caroline Connan in Paris. “Yes, we need to reduce our deficits.”
Finland, rated AAA by the three-biggest ranking companies, is increasing austerity measures next year even after its economy sank into a recession in the second quarter. The Nordic nation has cut spending and increased taxes to keep its top credit score.
U.K. Prime Minister David Cameron raised taxes and reduced outlays in 2010 to save its AAA rating, freezing pay for police, teachers, nurses and doctors, and capping welfare payments. S&P lowered its outlook on the country to negative from stable Dec. 13, citing the weak economy.
“Deciding on policy choices is the domain of governments and their advisors,” S&P said June 22 in a report. “We have not taken sides in the growth vs. austerity debate.”
Rating companies face increased regulation after a U.S. Senate panel found they provided inflated grades for risky mortgage bonds that helped cause the credit crisis in 2007 and 2008 that tipped the global economy into a recession.
An Australian judge ruled S&P misled investors by giving its highest ratings to securities whose value plunged during the global financial crisis. The company was “misleading and deceptive” in its grading of two structured debt issues in 2006, Federal Court Justice Jayne Jagot said in her Nov. 5 ruling.
The company will appeal, S&P President Douglas Peterson said Nov. 29 at a conference at Columbia University in New York. “We believe investors are sophisticated and have to read documents and actually have fiduciary responsibilities.”
Japan's Financial Services Agency last week said it ordered S&P's Japan unit to improve its system for verifying and updating ratings.
Policy makers have been searching for a way to ensure credit grades are accurate after the Dodd-Frank law in 2010 instructed regulators to stop relying on the ratings and increase oversight of the companies that issue them.
The European Union may require the companies to pick three days a year when they could give unsolicited assessments of governments' creditworthiness, according to Jean-Paul Gauzes, a lawmaker involved in the plans. They may get a chance to issue reports that haven't been requested and paid for by clients outside those dates if they can show regulators that events warrant them.
Bloomberg compiled data on changes in credit outlook and ratings along with bond yields for 30 countries as far back as 1974. They are Argentina, Australia, Austria, Belgium, Brazil, Canada, Chile, China, Colombia, Denmark, Finland, France, Germany, Greece, Indonesia, Ireland, Italy, Japan, Mexico, The Netherlands, New Zealand, Norway, Portugal, Russia, South Korea, Spain, Sweden, Turkey, the U.K. and the U.S.
The data measured government bond yields after a month relative to U.S. Treasuries, the benchmark measure for debt risk, to allow time for markets to adjust to assessment changes while minimizing the effects of subsequent unrelated events.
In a January 2012 analysis of Moody's rating changes, International Monetary Fund researchers looked at credit derivatives to show prices moved in the expected direction 45 percent of the time for developed countries and 51 percent for emerging economies. For outlook changes, the ratios were 67 percent and 63 percent.
“Do investors really care about another U.S. downgrade? My opinion is no,” James Sarni, senior managing partner at Los Angeles-based Payden & Rygel, which manages $75 billion, said Nov. 8 in a telephone interview. “It's part of a larger mosaic that ultimately determines what happens to rates.”