9 augustus 2011
U.S. Downgrade Shouldn’t Cause Liquidity Investors to Cash OutArticle Introduction

By PIMCO’s Jerome Schneider

•​Our sense is that that money-market funds and other short-term strategies seem well positioned for the aftermath of the downgrade.

•In the short-term, we believe U.S. Treasury bills will continue to be highly sought after as a short-dated liquidity alternative, especially by central banks.

•S&P’s downgrade should serve as another wake-up call to investors to continually determine their liquidity needs.

Undoubtedly investors around the world will be pondering the immediate and secular effects of the U.S. downgrade in the days ahead.  For short-term cash investors, however, we believe this is simply another step in the journey toward a new paradigm of active liquidity management that must be embraced as we continue to migrate away from old yield assumptions and instrument preferences.

Over the past few years, responses to a sudden dearth of liquidity and a single credit event have often been met with sharp pullbacks in investor participation in the markets.  Even as recently as last week, we observed the tremendous forces of fear and liquidity at work as investors in regulated money-market funds redeemed en mass prior to the resolution of the U.S. debt ceiling debates, with approximately $100 billion pulled from money markets over June and July alone, according to data from mutual fund trade group ICI. Once the ceiling had been raised and default avoided, however, investors headed back into the pool like kids on a hot summer day.

Our sense is that that money-market funds and other short-term strategies seem well positioned for the aftermath of the downgrade in light of the recent events that led up to the actions by Standard & Poor’s: Surprises are not a new phenomena for these investors.

S&P’s short-term rating for U.S. paper of A1+ remains intact, which will continue to provide ratings support for high quality money market portfolios.  Indeed, Treasury bills did not lose their rating, though investor concern likely will focus on the potential longer-term change in appetite for U.S. Treasury and Agency debt obligations, which in turn could affect their liquidity within the marketplace.  However, in the short-term, we believe U.S. Treasury bills will continue to be highly sought after as a short-dated liquidity alternative, especially by central banks.

There is a lack of supply in money market issuance, which may lead to technical dislocation in the repurchase (“repo”) and commercial-paper (CP) markets. But the repo markets are still the mainstay and cornerstone of our liquid financial system, which we believe means they should continue to function with a high degree of confidence.  Some participants might choose to alter margin requirements in light of perceived increased risks, but the risks they were facing are inherently no different than those same lenders faced last Friday when they went home.  Even a potential downgrade of Agency securities should be met with limited recalibration of higher-than- traditional haircut levels at this point, as investor appetites for underlying assets should remain relatively unchanged.

Make no mistake, S&P’s downgrade should serve as another wake-up call to investors to continually determine their liquidity needs. They must decide if the risk and reward that traditional liquidity management offer constitutes the correct approach in these game-changing times. They may come to the conclusion that their short-term strategies look beyond traditional confines to consider other instruments that offer reasonable, risk appropriate returns.