"Obvious" US Bonds Junk... Considering Key Ratios, Future Outlook

It’s the burning question that can’t be denied — do US bonds make sense with the current triple-A rating and low yield? Or, is “quite obvious” they instead deserve a junk rating? Of course, China-based Dagong Credit Rating Agency has already argued vehemently the US should have a lower rating, in particular lower than China. A recent contribution from Daryl G. Jones, managing director of investment research firm Hedgeye, offers another indication the lower-rating perspective is gaining traction here in the US.

From Fortune:

“But while investors are willing to accept little in the way of return to own U.S. government debt and the U.S. has retained its AAA credit rating, the metrics by which we use to evaluate the balance sheet of the United States continue to deteriorate.

“Typically, a bond receives junk status due to its increased risk of default, and therefore pays higher yields to the owners of the bonds to make up for the risk. In general, the owner of a bond is subject to many risks: interest rate risk, inflationary risks, currency risk, duration risk, and so forth. In this instance, as it relates to the United States, we are actually most concerned with the risk related to future repayment. Specifically, with projected deficits for at least the next fifty years, will the United States be able to repay its debt and, if so, on what terms?”

Jones specifically also adds a breakdown of the key ratios that directly compare Greece and the United States:

“Deficit as % of GDP
* US: 10.4%
* Greece: 13.6%

“Debt as % of GDP
* US: 86.5% (including GSE debt: 121.6%)
* Greece: 115.1%

“Debt as % of revenue
* US: 358.1%
* Greece: 312.2%

“Sources: Hedgeye, Morgan Stanley and CBO. 2009”

The ratios suggest, and Jones agrees, that the US would benefit from the same kind of austerity measures Greece is currently imposing. This is because even under the government’s own existing Congressional Budget Office projections debt is only going to continue to increase as a percentage of GDP. As he describes:

“…And the outlook of the United States is distressed to say the least. The Congressional Budget Office projects the U.S. budget out until 2035 under two scenarios. In both scenarios, the U.S. government will run a deficit through the projection period and require increased debt to fund the deficit. In the more aggressive scenario, in terms of larger deficits, debt as percentage of GDP nears 200% by the end of the projection period. Hedgeye actually believes that even the more aggressive scenario could understate future deficits.”

This view — perfectly at home here in The Daily Reckoning — becomes more prevailing as it appears in the likes of Fortune. It also offers further evidence that, even if the US won’t be plummeting to junk status tomorrow, it’s still creeping toward, as a first step, losing its triple-A status. Dagong would be quick to lend emphasis to the chorus, if it ever manages NRSRO status.

You can more details in Fortune’s coverage of whether US government debt should be rated junk?


Rocky Vega,
The Daily Reckoning