Why the Market Yawned at the S&P's U.S. Credit Rating Outlook Upgrade

When Standard & Poor's upgraded the outlook for U.S. credit rating from negative to stable on Monday, Wall Street hardly seemed to notice.

The mild market reaction was a stark contrast to the sharp downturn back in August 2011, when the Congressional standoff over the raising the federal debt ceiling prompted S&P cut the U.S. credit rating to AA+ from the top-tier AAA.

But while the improved outlook is welcome, a return of the U.S. credit rating to AAA status isn't expected any time soon.

"Generally these things don't happen in just a few years," said Nikola Swann, S&P's sovereign ratings director.

S&P listed the fiscal cliff deal and stronger-than-expected private-sector contributions to economic growth, combined with increased remittances to the government by the government-sponsored enterprises Fannie Mae and Freddie Mac, as reasons for the upgrade to the U.S. credit rating outlook.

What's more, S&P said, government debt as a percentage of gross domestic product should stay stable at about 84% for the next few years, the agency said.

"The improving U.S. economy is boosting government revenues, the sequester has trimmed spending, and uncertainties about growth in China and Europe make the U.S. the preferred destination for global investors," Phillip Swagel, former Treasury assistant secretary for economic policy in the George W. Bush administration, and now a professor at the University of Maryland, told Bloomberg News.

Still, Washington hasn't done anything to help its case. In addition to the recurring debt ceiling debate, lawmakers continue remain at logger horns over the federal budget, all of which has served as a drag on the U.S. economy, which is still struggling to grow above 3%.

"We believe that our current 'AA+' rating already factors in a lesser ability of U.S. elected officials to react swiftly and effectively to public-finance pressures over the longer term in comparison with officials of some more highly rated sovereigns, and we expect repeated divisive debates over raising the debt ceiling," S&P said in a statement.

Even so, the S&P said the U.S. now has less than a one-in-three chance of a downgrade in the near term, but one could come if there were a deliberate attempt by Washington to either increase deficits or forestall plans to cut the deficit.

Upgrade Won't Stop Upcoming Market Crash

Monday's market reaction was a hiccup compared to the two weeks of turmoil generated by the 2011 downgrade to the U.S. credit rating.

"I don't think any rating agency's rating of any sovereign is that important any more, unless they drop a rating multiple notches at once," says Money Morning Capital Wave Strategist Shah Gilani. "Any time they move a rating of a sovereign up or down a tick, it's like pointing out that the Titanic is a degree or two off course. It's what's ahead that matters, not what an analyst sees in his or her crystal ball."

Following Monday's upgrade the markets sold off after opening higher and finished basically flat with the Dow dropping 9.50 points, or only 0.06%, and the S&P 500 falling 0.57 points, or 0.03%.

In 2011, however, the S&P 500 fell about 6.3% and the Dow Jones Industrial Average slipped 5.5% in the two weeks after the downgrade. That followed a 10.8% slide for the S&P and a 9.7% fall for the Dow over the prior two weeks.

While a restoration of the AAA rating probably would have gotten a more dramatic market reaction, the upgrade just to the outlook was simply not enough to get Wall Street's attention.

"The markets are oblivious as to what rating agencies blather on about," Gilani said. "A tick or two doesn't matter, as long as they aren't carrying lyme disease. And the real doctor, the market, is still assessing the patient."

And even though the upgrade might have been warranted, it doesn't mean the economy is in clear waters just yet.

"If you'd asked me to guess, I'd have said we'd get tax increases but no spending cuts from the fiscal cliff talks, so I think an upgrade was merited," Money Morning Global Investing Strategist Martin Hutchinson said. "Unfortunately, sloppy monetary policy is setting us up for the most almighty market and economic crash in about a year's time, so I regard the improvement as strictly temporary."

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