Can rating agencies look through the cycle?

Rating agencies claim to look through the cycle when assigning corporate credit ratings,which entails that they are able to separate trend components of default risk from transitoryones. To test whether agencies possess this competence, I take market-based estimates of oneyeardefault probabilities of corporate bond issuers and estimate their long-run trend using theHodrick-Prescott filter, local regression, or centered moving averages. I find that ratings helpidentify the current split into trend and cycle. Their stability is similar to the one ofhypothetical ratings based on trends. Since the examined trends are forward-looking, agencyratings exhibit important characteristics one would expect from ratings that see through thecycle.