Daryl G. Jones
A few weeks ago, Hedgeye, the investment research firm where I’m a managing director, hosted a conference call for our subscribers that posed the question, “Should U.S. Government Debt Be Rated Junk Status?” Given that debt issued by the U.S. government continues to trade at almost all-time lows in yield, this is a contrarian call to say the least.
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?
The most newsworthy nation to currently be rated junk status is Greece. The 5-year credit default swaps for Greece, which reflect the amount an investor is willing to pay for insurance against a potential default, are currently trading at 916 basis points(bps) which is substantially above the levels of the United States. In fact, credit default swaps for the American government 5-year bonds are trading at 49bps which reflect the AAA bond rating status of the United States.
In contrast to the price of both yields and credit default swaps, the key ratios from which we use to analyze a nation appear very similar between the United States and Greece, despite their divergent credit ratings. Specifically, the key ratios are: debt as percentage of GDP, deficit as a percentage of GDP, and debt as a percentage of revenue. We’ve outlined a comparative analysis between a typical junk-rated sovereign issues, in this case Greece, and the United States.
The key ratios: Greece vs. 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