Still, the talk in Washington of a federal budget crisis and possible default has given rise to all sorts of consumer fears of doomsday scenarios. Missed Social Security payments. Spikes in interest rates. Draconian cuts in government services.
But the most likely outcome, experts said in interviews this week, is that the nation’s credit rating will be downgraded a notch. And if that turns out to be the case, investors and borrowers should be able to ride out any volatility.
Over the last few days, financial advisers have tried to allay investor fears by sending notes to clients with the same message they have delivered in past periods of market uncertainty: As long as you’re diversified across different investments, the best action, in this case, is inaction.
The financial markets may become more volatile in the near-term, they say. And interest rates on several types of consumer loans can be expected to tick modestly higher because the rates track government-issued debt. But a credit downgrade is unlikely to cause a major shock to the system.
That said, the only investment that did not plunge in the 2008 market crisis was Treasuries, and they could conceivably lose some of their luster. “Sometimes I worry that a U.S. debt downgrade could have long-term negative psychological consequences as Americans realize the greatest power on earth is, alas, a mere mortal too,” said Milo Benningfield, a certified financial planner in San Francisco. But “we’re still looking pretty good relative to most everyone else in the world.”
That does not mean there will not be a wide ripple effect, at least in the short term. The magnitude of the deficit reductions and their effect on the broader economy are another wild card. But in the near term, here’s what investors and consumers can expect, and some advice from experts.
STOCKS AND BOND INVESTMENTS Both the stock and bond markets are expected to endure a period of volatility if the nation’s debt drops a notch from its AAA perch. “Once a plan is in place, we would expect the markets to return to normal, and for investors to focus on more fundamental issues like long-term earnings growth and the economic health of countries around the globe,” said Gus Sauter, chief investment officer at Vanguard.
“That said, it’s simply not possible to gauge precisely how the equity and fixed income markets would react and for how long, so the best course of action is to ignore the headlines and maintain a long-term approach.”
That sort of advice might come as cold comfort to people on the cusp of retirement, and for whom the memories of the recent downturn are fresh. That is why many advisers suggest that people who are living off their investments set aside enough cash so that they are not forced to sell investments during a rough patch.
“This is certainly creating a lot of concern, and the games being played in Washington by Congress are increasing the stress,” said Diahann Lassus, a financial planner in New Providence, N.J. “Cash reserves are very important for both retirees and pre-retirees.” She suggests six months to two years in cash, depending on the investor’s age and specific situation.
A downgrade may cause Treasury yields to move modestly higher, which, in turn, may cause corporate, municipal and other bond issues to follow suit. Budget cuts, though, may have a more serious effect, depending on their severity. “If they really make some severe cuts, that is deleterious to the municipal bond space,” said Marilyn Cohen, chief executive of Envision Capital Management, which manages bond portfolios. “That means less trickle-down to the states, cities and counties.”
But if there are not enough cuts, she said, that could also cause the broader bond market to swoon.
MONEY MARKET FUNDS These funds hold 40 to 45 percent of the shorter-term Treasury debt outstanding, according to Deborah A. Cunningham, chief investment officer for money markets at Federated Investors. But if the nation’s debt rating were downgraded, these funds would not be required to sell the Treasuries they hold. In fact, a fund would not be required to sell in the event of a default, either, as long as the fund deems the securities to be safe and able to make their interest payments.
“The money market world asset flow, what comes in and goes out, has been pretty benign,” Ms. Cunningham said.
And she said she would not expect a downgrade to change those flows in any significant way. “The debt that is held in money market funds is so short in maturity that a downgrade will just not be an event that causes any kind of pricing concerns. As such, there shouldn’t be issues for investors.”
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