Wall Street Reacts To Credit Downgrade

At the opening bell on Wall Street today, stocks took a predictable dive in the wake of Friday's action by Standard & Poors, downgrading U.S. debt from AAA to AA. The Dow Jones Industrial Average was down 200 points in early trading.

But perhaps not quite so predictable was the U.S. bond market, where investors buy U.S. debt. With a credit downgrade, you might expect fewer investors would want to lend the U.S. money by purchasing bonds. But the opposite is true.

While world stock markets are selling off, money is pouring into U.S. 30-year bonds. That's right, the debt that has just been downgraded is apparently viewed as a safe haven in times of turmoil. It's ironic, perhaps, that the turmoil is being caused by the downgrading of the debt to which money is now flowing.

Of course, not everyone has downgraded U.S. debt. Fitch and Moody's last week reaffirmed the U.S.'s AAA rating. S&P said it took its action because it believes the U.S. debt level is still too high, despite Congress's last minute debt-ceiling deal last week, and suggests more downgrades are possible unless Congress shows some budget discipline.

How sound is prevailing wisdom?

What does all of this mean for consumers? The prevailing wisdom has been that a credit downgrade would be very bad for both business and consumers because it would lead to higher interest rates. Rates would rise, the argument went, because U.S. debt would be seen as riskier, and less attractive.

Therefore, to sell the same amount of bonds, the Treasury Department would have to offer higher interest rates on those bonds. Those Treasury rates would then set the bar for all types of loans, including mortgages.

So far, however, that doesn't seem to be playing out. Mohamed El-Erian, co-CEO of bond giant Pimco, told business news channel CNBC that the S&P downgrade wasn't caused by a belief the U.S. might default on its debt, but rather by concern the U.S. wasn't taking steps to solve long-standing economic problems.

That suggests that interest rates could stay low as investors seek a safe place to park money. U.S. debt still seems safe, compared to many alternatives.

Gold still glitters

Another alternative is gold, and the precious metal set another record high in early trading today. Gold prices surged past the $1700 an ounce mark on the New York Mercantile Exchange in the first hour of trading.

Traders say gold is drawing buyers who are concerned the Federal Reserve might resort to another round of “stimulus” for the economy, which is viewed as weakening the dollar.

Oil prices, on the other hand, are falling rapidly, with prices falling below $85 a barrel in early trading on the New York Mercantile Exchange. At that level, retail gasoline prices should fall to around $3.35 a gallon, some analysts say. They have yet to do so, however, with the national average price of self-serve regular at $3.66 a gallon, according to AAA.