A failure by politicians in Washington to reach a deal to raise the U.S. debt ceiling in the next few days -- particularly if  Standard & Poor's makes good on its threat to lower the country's AAA sovereign debt rating -- could have “deep and wide reverberations” in credit and equities markets, according to Todd Rosenbluth, an analyst at S&P Equity Research.

But it might not automatically hurt investors in mutual funds that are invested heavily in U.S. Treasuries and related government bonds.

Rosenbluth cites the three largest bond mutual funds that use a “U.S. Securities investment style” -- all of them with assets of more than $3.5 billion -- and said that while they would move into a higher risk status if the U.S. credit rating was cut from AAA to AA, “there could be an offset to that risk, since the yield on the AA bonds would be higher than on the AAA bonds.”  

The three bonds studied by Rosenbluth were the JP Morgan Core Bond Fund (PGBOX), a five-star rated fund that is 43% in mortgage bonds, 26% in government bonds and 15% in corporate bonds; Fidelity Government Income Fund (FGOVX), a four-star fund that is 43% in government securities, 11% in mortgage bonds, 10% in agency bonds and that also has some derivatives, and American Funds US Government Securities Fund (AMUSX), a four-star fund with 40% US government bond, 33% mortgage bonds and 23% agency bonds.

"While it could be that the funds would not go down in value because of rising yields, for some investors, who invested in these funds because of the very low risk, any increased risk would be too much," Rosenbluth said. 

"We’re not saying that anyone should steer clear of these or any bond funds," he added. "But they should be aware of the fact that the risk will rise if there is no deal on the debt ceiling, and if the U.S. credit rating is lowered."

S&P Ratings Service, which is separate from S&P Equity Research, has put a negative watch on U.S. debt and could lower America’s sovereign rating from AAA to AA as early as mid-August if there is no major deal passed by Congress to significantly cut the national budget.

Rosenbluth said that it is difficult to predict how individual bond funds will react to a U.S. debt downgrade. "These funds have a lot of moving parts," he explained. "And also, fund managers could shift their holdings to shorter bonds to offset risk."

He added that to the extent that bond funds did suffer from any temporary default or from a ratings downgrade, they might not move in the rankings because other funds in the same group would be similarly impacted.



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