El-Erian: Making Sense of Today's News

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Why isn’t the price of U.S. Treasurys falling after the S&P downgrade? Why are equities under pressure? And why is gold surging?

Developments in Treasurys appear, at first sight, the most puzzling.

After all, their issuer, the U.S. government, has been stripped of its triple-A rating and, to add insult to injury, the new AA+ rating has been assigned a negative outlook.

Remember, US Treasurys reflect the combination of financial (debt, deficits and ratings), fundamental (economic), technical, and policy influences.

Monday morning, the impact of the first is being understandably overwhelmed by the other three—in market jargon terms, the credit component of Treasurys is being dominated by the interest-rate component.

Here’s why:

  • The S&P action is a further hit to already-fragile business and household confidence. As such, markets are revising down their outlook for economic growth in the U.S.
  • This—and, more generally, the material uncertainty and volatility of the last few weeks—induces flows of funds out of the equity markets. A part of the outflow ends up in Treasurys as this market segment remains the most liquid and deepest of them all.
  • Finally, some believe that the pressure for the Federal Reserveto act—another round of quantitative easing?—is increasing. If this occurs, the Fed could once again become a buyer of Treasurys.

All this also speaks to why equities are lower. A darker outlook for economic growth translates into lower corporate revenue growth and lower profits.

As for gold, a growing number of investors see it as the store of value. It is also becoming more of an alternative in a world where most countries are effectively debasing their currencies.

In sum, S&P’s action is much less about America’s ability to repay its government debt and much more about the continued failure of policymakers to get their arms around the problems undermining growth, employment, financial soundness, and prosperity.

Mohamed A. El-Erian is CEO and co-CIO of PIMCO, and author of "When Markets Collide."