BREAKINGVIEWS - Don't blame S&P for the madness of markets

A trader works on the floor of the New York Stock Exchange, August 2, 2011.

(The author is a Reuters Breakingviews columnist. The opinions expressed are her own.)

By Agnes T. Crane

NEW YORK (Reuters Breakingviews) - Don't blame Standard & Poor's for the madness of markets. The credit rating agency targeted U.S. debt, but it was stocks not Treasuries that got clobbered on Monday. The counterintuitive reaction, however, is less bonkers than it seems.

The S&P 500 index tumbled more than 6 percent, with financial institutions getting hit hardest. Bank of America lost over a fifth of its market value at one stage. It may not look rational, especially after Corporate America spent the last three years repairing balance sheets and banks adding to their capital cushions.

The value of America's debt, meanwhile, soared. The 10-year Treasury yield fell to as low as 2.33 percent, a whopping 0.23 percentage point less than the already low level on Friday. The security's status as a safe haven for panicky investors certainly helped the government debt market shake off the S&P downgrade. But the magnitude of the rally combined with the bloodbath in stocks and other risky assets indicate something more at work. It could be the punch of the downgrade had less to do with U.S. creditworthiness and so much more with the reality check it provided investors about America and its economy.

Global stocks had already taken a beating before the downgrade. The troubled euro zone, weak U.S. economic data and the debt ceiling fiasco unnerved those who believed the Federal Reserve's double-barreled monetary policy eradicated any chance of a double-dip recession. The U.S. high-yield bond market now puts the chance at 30 percent and climbing, according to Martin Fridson, a strategist for BNP Paribas.

Those odds are scary enough. More frightening, though, is the paucity of levers to pull to alter it. S&P's verdict is a stark reminder that Washington has become so dysfunctional that lawmakers couldn't devise a credible plan to solve the nation's longer-term deficit problems. That makes a short-term fiscal fix, like another stimulus plan, even more remote. Meanwhile, the Fed, which has already dabbled with experimental policy to limited success, doesn't have much more in its tool bag to get the economy back on track.

All of it bodes far worse for sentiment on both Wall Street and Main Street than any single-letter grade change could possibly do.

CONTEXT NEWS

-- The S&P 500 fell 6.66 percent on Aug. 8, the first day of trading since Standard & Poor's downgraded America's credit rating from AAA to AA-plus. The S&P 500 is now well below where it stood when the Federal Reserve launched its $600 billion bond purchasing program in November 2010 to boost the economy. Stocks of financial companies, including Bank of America and Citigroup, were among the hardest hit.

-- The Nikkei 225 index fell 2.2 percent, while the FTSE 100 index dropped 3.4 percent.

-- The yield on benchmark 10-year Treasury bonds fell as low as 2.33 percent, down 0.23 percentage point from Friday.

(Editing by Jeffrey Goldfarb and Martin Langfield)