Fitch and Standard & Poor's both downgraded the U.K. to AA (from AAA) this week in response to the Brexit vote (politico.eu article). As experienced market watchers would expect, U.K. gilts have been rallying (yields falling), which is not the usual narrative that one hears about ratings actions. This article explains why bond investors treat credit ratings for free-floating developed sovereign governments as sources of entertainment, and not investment guidance.
As I discuss at length in Understanding Government Finance (paperback edition will be published shortly), developed sovereigns with a free-floating government are not at risk of involuntary default; rather the risk is of voluntary repudiation of debt. Although some investors have been slow learners about this reality -- take the parade of JGB shorts -- most government bond investors have accepted this reality.
Although credit ratings are unfortunately worked into bond indices, bank regulations treat the sovereign issuer as special, with a 0% risk weighting, Furthermore, everyone knows that the government cannot be forced to default. This knowledge either comes from something resembling Modern Monetary Theory's analysis of governmental finance operations, or the more primitive "they can just print the money."…Bond Economics
Another Example Why Bond Investors Ignore Developed Sovereign Credit Ratings