AAA-rated fixed income assets are a species in decline, as rating agencies re-evaluate the ability of highly indebted nations to reduce their burdens. The UK is the latest country to have its AAA rating called into question.
So far, the UK has managed to keep hold of the highest possible rating despite growth forecast downgrades, higher debt levels and an extended time horizon required to fix the country’s finances. Last week’s Autumn Statement was another frustrating experience for George Osborne, the UK’s Chancellor of the Exchequer, as it again highlighted that this debt deleveraging cycle is going to be longer and more painful than he originally forecasted.
When the coalition government came into power in the summer of 2010, they set two fiscal targets:
- Eliminate the structural deficit within five years
- Begin to see public sector net debt fall by 2015/16
As austerity fatigue builds across Europe, the chancellor has cited both the International Monetary Fund (IMF) and the Organisation for Economic Co-operation and Development (OECD) as stating that while they support his austerity plans, if the economic outlook declines, he should not accelerate tightening just to maintain his fiscal targets. Two and half years later, it is still expected to take another five years to remove the structural deficit, and public sector net debt is now not expected to start to decline until 2016/17 at the earliest. Given expectations of ongoing anaemic global growth, the UK economy could well continue to undershoot the Office for Budget Responsibility’s growth forecasts, leading to further revenue shortfalls and deficit target misses. This in turn will lead the rating agencies to take a long, hard look at the UK.
In reality, the impact of the UK losing its AAA rating is unlikely to negatively affect Gilts and push their yields higher. Just under a month ago France lost its second Aaa rating, this time from Moody’s, and its ten-year bond yields have since fallen to record lows. Five years ago, over 50% of the Barclay’s Global Aggregate Bond Index was rated AAA by S&P and Aaa by Moody’s, and today this number has fallen to around 17%. In the animal world, AAA-rated assets would be classified as a vulnerable species that could well become endangered. We are moving towards an environment where AA could well become the new AAA.