Are You Freaking Out About a U.S. Downgrade Yet?

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While traveling over the weekend, I was asked on a few occasions whether I was concerned about the debt-ceiling talks. The short answer was "yes." I have been aghast at the idiocy and posturing in Washington over what should essentially be a procedural vote. Yes, we've been here before, but that doesn't make the boneheadedness any less jaw-dropping.

With that in mind, it was with a little surprise that I read a couple of articles featured on Yahoo! Finance this morning essentially arguing that a U.S. downgrade from the major bond-rating firms wouldn't be all that big of a deal. My first reaction: "Insanity." But there may be some truth to that; after all, the bond markets are massive beasts that often seem to do whatever the heck they want to do.

A look at the yields on bonds for some of the top- and second-tier sovereigns shows that there's no law that says a Moody's (NYS: MCO) Aa1 has to yield x%.

Top Tier Borrower

Moody's Rating

S&P Rating

10-Year Bond Yield

Australia

Aaa

AAA

4.98%

Canada

Aaa

AAA

2.89%

France

Aaa

AAA

3.20%

Germany

Aaa

AAA

2.65%

Netherlands

Aaa

AAA

3.17%

Singapore

Aaa

AAA

2.18%

Switzerland

Aaa

AAA

1.53%

United Kingdom

Aaa

AAA

2.99%

United States

Aaa

AAA

2.97%

Sources: Moody's, Standard & Poor's, Bloomberg, The Wall Street Journal, Trading Economics, The Financial Post.

Second Tier Borrower

Moody's Rating

S&P Rating

10-Year Bond Yield

Belgium

Aa1

AA+

4.27%

China

Aa3

AA-

4.11%

Hong Kong

Aa1

AAA

2.29%

Italy

Aa2

A+

5.41%

Japan

Aa2

AA-

1.09%

Spain

Aa2

AA

5.77%

Sources: Moody's, Standard & Poor's, Trading Economics.

On the whole, the second-tier group is saddled with higher rates than the top tier. But this hardly tells the entire story. Belgium and, more so, Italy and Spain are under the storm clouds of the euro region's fiscal woes. In fact, if we look to the top-tier group, both France and The Netherlands (same storm clouds) are among the highest yields. And surely Japan and Hong Kong make a strong case that you don't need perfect ratings to maintain low bond yields.

Directionally, a sovereign downgrade would almost certainly push U.S. yields up
(meaning bond prices fall), but "skyrocket" seems to be a very Chicken Little choice of words when talking about a one-notch ratings downgrade.

So, am I still worried? Of course. Moody's and S&P may downgrade the U.S. regardless of whether we get the debt ceiling raised. But if this inane dithering takes us past Aug. 2 and there's even a sniff of default, we're talking a very different matter. Countries that default don't get Aa1 ratings. Want to see what it looks like when the bond market loses confidence in you? Check out the yields on Greek or Brazilian bonds.

What really keeps me up at night, though, is that I don't think many of those gumming up the Washington gears right now understand any of this. Maybe this shouldn't surprise me -- my fellow Fool Morgan Housel has pointed out that nearly half of all American's don't have a basic understanding of interest rates -- but it sure as heck scares the pants off me for now and the future.

At the time this article was published Motley Fool newsletter services have recommended buying shares of Moody's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.Fool contributor Matt Koppenheffer does not have a financial interest in any of the companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or Facebook. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.

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