As headlines debating the likelihood of a US debt downgrade mount, it’s worth examining whether a downgrade would materially impact demand for US Treasurys.
Globally, there’s a total of $17.2 trillion in outstanding AAA-rated sovereign debt securities from 19 issuers. US Treasurys account for $9.5 trillion (55%) of the total, with France, Germany and the UK each representing around 10%.
Exhibit 1: Global Distribution of AAA-Rated Sovereign Debt Securities by Issuing Country
Sources: Thomson Reuters, Bloomberg Finance LP.
In the event the ratings agencies downgrade US debt, investors who want only AAA-rated debt won’t have many options. The UK and France are in arguably worse fiscal positions than the US (after all, it’s the debt ceiling-related political tug-of-war, rather than extant structural problems, that’s mostly escalating talk of a US downgrade). And while Germany remains strong, its government doesn’t issue enough debt to meet the needs of AAA-seeking investors following a US credit downgrade. The remaining AAA-rated sovereign debt comes from smaller countries that lack sufficiently liquid credit markets to absorb any significant capital inflows.
Investors may not like a US credit downgrade, but given the relative lack of viable alternatives, it seems unlikely a downgrade would prompt a mass exodus from US Treasurys. Tellingly, since talk of a downgrade began in earnest in April, 10-year Treasury yields have fallen and are currently just under 3%—perhaps counterintuitively, demand for US debt has increased as our fiscal situation has supposedly become more tenuous. This underscores the fact US Treasurys remain the safest, most liquid sovereign debt securities despite what S&P, Fitch or Moody’s might say. In our view, a US downgrade shouldn’t materially hurt demand for US Treasurys.