By Jonnelle Marte
Moody’s Investors Service on Tuesday became the first ratings firm to warn the U.K. that its triple-A rating may be at risk — a move pros say could be another blow to safe-haven-seeking investors.
Moody’s lowered its outlook on the U.K., citing concerns that a slower macroeconomic environment could disrupt the government’s efforts to reduce its debt; the firm also cut the ratings of six European nations. But while investing pros were expecting the euro-zone downgrades, the U.K. warning caught many by surprise. “It’s an indication that the European weakness is going beyond the euro and affecting nearby countries,” says Anthony Valeri, fixed income strategist for LPL Financial. “It just throws more uncertainty into the bond market.”
Advisers say the warning is yet another reminder that the pool of highly rated countries, which bond investors seek out as safe havens for their cash, is dwindling. The downgrades and warnings come at a time when investors are looking for stability, amid rocky market performance, high unemployment and slower economic growth. Even countries with top-notch ratings are struggling with high debt levels and experiencing slower economic growth because of the impact of neighboring countries, says Colin Robertson, head of fixed income for Northern Trust. As a result, investors seeking high quality bonds are turning to countries that previously went unnoticed, like Canada, which recently launched a dollar-denominated government bond to take advantage of new investor interest.
Of course, experts point out that Moody’s negative outlook won’t necessarily lead to a downgrade. The U.K. already has several austerity measures, including spending cuts and tax increases, in place aimed at reducing its debt, says Robertson. And even a downgrade might not change the way investors view and the bonds, says Ted Bovard, an adviser with Pittsburgh- based Fort Pitt Capital Group. Treasury bonds, for instance, rallied after Standard & Poor’s stripped the U.S. of its triple-A rating, he says. “Which is exactly the opposite of what everyone would have thought,” says Bovard.
Still, analysts say the recent downgrades could spread to other countries. For example, some analysts say S&P’s downgrade of France from Aaa to Aa was partly due to the fallout from a similar downgrade of the U.S. Such ratings changes could lead foreign bond investors to rethink how they view a bond’s quality, says Robertson. Recent ratings actions are making Treasury investors, and now U.K. bond investors, aware that even top-rated government bonds carry risk, says Robertson. And with several credit ratings in flux, it can become harder to compare bonds or pinpoint safer buys when shopping between countries, says Valeri. That can lead to fluctuation in bond prices and yields as investors shuffle money between regions, pros say. “It makes it harder for investors to value other forms of debt,” says Valeri.
Advisers say the changes could lead investors to seek safe alternatives beyond sovereign bonds. Investors looking for stability might consider mortgage bonds backed by Fannie Mae, Freddie Mac and Ginnie Mae, says Valeri. The bonds are guaranteed by the federal government and offer a yield advantage of roughly 1.3 percentage points over comparable Treasurys, says Valeri. Some investors may also want to turn to high quality corporate bonds, says Bovard. Companies continue to grow profits, albeit at a slower pace than in previous quarters, a sign that most are able to make good on their bond payments, says Valeri.