Tim Hext: what the NSW and Victoria ratings downgrades mean for investors

Portfolio manager Timothy Hext from Pendal's Bond, Income and Defensive Strategies team.

How many As are enough?

School reports are out this week and for highly driven students (and some parents) anything less than an A is disappointing. For others a single A can be a source of celebration.

Two Australian states this week lost an A.

S&P downgraded NSW from AAA to AA+. This came as no surprise given the massive increase in debt this year.

More surprising though was Victoria, which was double downgraded from AAA to AA, falling from the equal highest-rated state to the lowest.

Victoria has had a double downgrade before. In 1992, while struggling to emerge from a severe recession and the collapse of the State Bank of Victoria, the state was hit by a double downgrade from Moodys.

There were massive blowouts in the spreads of Victorian bonds and a sense of panic crept in. The downgrade was viewed as unacceptable by the new Liberal government of Jeff Kennett, which embarked on a program of asset sales and expense control to regain the AAA. It took six years.

Today we live in very different times. We no longer have mainstream economists and supposed experts like the IMF recommending a dose of large fiscal cuts as the remedy. Cutting government spending at a time of large private sector cuts is seen for the stupidity it always was.

More importantly at a federal level there has been a gradual realisation over the past 20 years that a government in control of the printing press has far more debt and fiscal capacity than previously thought.

Pendal named 2020 Fund Manager of the Year in Zenith Awards.

We can thank Japan for first experimenting with what were then considered the “crazy” ideas of Modern Monetary Theory.It turns out the framework behind MMT is actually right — something that has embarrassed the many mainstream economists who predicted doom.

Since the facts disrupted the views of these economists they have been busy trying to exercise a triple reverse twist dive to pretend they could see this all along. Even worse, some are revealing their continued ignorance of MMT by still referring to it as “an impossible free lunch”.

This time governments and markets have correctly shrugged their shoulders at these downgrades as largely ho hum.

The cost of debt has barely budged. The RBA and banks chasing High Quality Liquid Assets are soaking up the extra supply. Debt has never been cheaper.

Governments have learned that the welfare of their citizens, particularly in a crisis, is more important than an extra A in the credit rating.

Over the next decade it will be inflation — not the rating agencies — that limits what a government can do. If inflation emerges it will hopefully be the “good kind” brought about by a strong economy, which would be fixing government finances.

The bad kind of inflation — supply-driven or stagflation — would be a different matter.

But that is a topic for another time.


Tim Hext is a portfolio manager with Pendal’s Bond, Income and Defensive Strategies team.

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