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Negative outlook

Yesterday afternoon, the rating agency Moody’s downgraded the outlook for U.S. government debt to negative. The other two major rating agencies, S&P and Fitch have already downgraded U.S. debt to AA+. The report from Moody’s acknowledged the strength of the U.S. economy and reiterated the AAA rating. However, the fiscal deficit and the subsequent increase of debt to cope with the deficit, pushed the agency to assign the negative outlook. The implications if the U.S. were to loose the top rating may not be critical, but in practical terms, most financial contracts require AAA collateral, which if downgraded will imply a rewording of agreements, and a potential increase in the cost of operations, since yields should increase. As you can see below, the U.S. 5 year CDS, a risk thermometer for U.S. debt, is structurally rising, with periodical spikes when the debt ceiling negotiations kick in. Lack of demand for treasuries and financial deterioration will increase the overall cost of all debt, as it is also transmitted to corporates.

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