J.P.Morgan On The Impact Of The Fitch Downgrade

In light of Fitch downgrading the U.S. J.P.Morgan note that “each notch of ratings downgrade across the 3 rating agencies tends to cheapen 5-year Treasuries by about 8.4bp relative to matched-maturity OIS. Thus, this one-notch downgrade from Fitch should narrow 5y swap spreads by approximately 2.8bp, all else equal. However, we note that Treasuries already seem to display a higher risk premium than other similarly-rated DM sovereigns, indicating the cheapening could be more muted than these coefficients imply.”

• “Certainly, Treasuries saw elevated volatility in 2011 following S&P’s downgrade, but we would argue the U.S. economy was on very different footing at the time. Notably, the spending cuts that ended the debt ceiling crisis of 2011 reduced federal spending by 0.7% of GDP the following year, while the deal signed into law earlier this year is expected to lower federal spending by less than 0.2% of GDP next year.”
• “Moreover, the unemployment rate was elevated at 9% then, and the Fed would unveil Operation Twist just a month later at the September 2011 FOMC meeting. Thus, we do not expect to similar levels of volatility in coming weeks, given the resilience of the U.S. economy and the tightness of labor markets.”