The unique global status of the US dollar and financial markets, as well as the strength of the US economy, have enabled the government to maintain its current rating. “A large, dynamic economy, the dollar’s role as a reserve currency, and the depth and liquidity of U.S. capital markets are important strengths when evaluating sovereigns,” Fitch said. But a series of “governance” problems under the Trump administration, as well as the conflict in the Middle East and persistent and growing budget deficits, have called that creditworthiness into question.
Still, U.S. Treasury bonds have attracted global investors as a “safe haven” during the conflict. Other countries such as Great Britain do not currently have this status. British 30-year government bonds, known as gilts, have reached their highest level since 1998. And the benchmark 10-year British bond yield was almost 5 percent, a premium of more than 0.6 percentage points over the equivalent government bond.
The world’s major central banks have reacted defensively to these financial storms. As I wrote last week, the Bank of Japan, the European Central Bank, the Bank of England and the Federal Reserve have all decided not to take action on their key interest rates because rising oil prices resulting from the war with Iran pose a dual risk: there is an increased risk of both runaway inflation and stunted economic growth.
This dilemma still exists. Kevin M. Warsh, nominated to succeed Jerome H. Powell as Federal Reserve chairman, has often spoken about the need for a rate cut, but markets are skeptical. The most likely outcome is that the Fed will not take any interest rate action until December 2027, with a greater likelihood of rate hikes than rate cuts, according to futures prices tracked by CME FedWatch.
In short, the central banks, which control the shortest-term interest rates, and the bond market, which sets the longer-term interest rates, view the economic environment with a critical eye. There are a range of possibilities, from prosperity in many developed markets to chaos as conflict intensifies in the Middle East. Fixed income markets tend to focus more on risk than on the potential for unexpected gains that the stock market values.