 S&P blames misdiagnosis of crisis by European Council as reason for its downgrade
The news over the weekend was obvious dominated by the S&P’s downgrade nine eurozone countries and the breakdown of debt restructuring talks in Greece.
What is more interesting than just the decision by S&P itself is the reasoning. The rating agency said it feels that the December summit failed to address the actual crisis, which consists of tightening credit conditions, an increase in risk premiums, a simultaneous attempt to delever by governments and households, weakening economic growth prospects, and an open and prolonged dispute among policymakers on how to address the challenges.
The following is really important, and we quote in full:
“We also believe that the agreement is predicated on only a partial recognition of the source of the crisis: that the current financial turmoil stems primarily from fiscal profligacy at the periphery of the eurozone. In our view, however, the financial problems facing the eurozone are as much a consequence of rising external imbalances and divergences in competitiveness between the eurozone’s core and the so-called “periphery”. As such, we believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating, as domestic demand falls in line with consumers’ rising concerns about job security and disposable incomes, eroding national tax revenues. “
This is a statement we would wholly agree with.
Here is current S&P’s table of sovereign ratings:
Even though the downgrade was perfectly foreseen, except for the precise timing, the markets reacted negatively. 10 year Bond spreads widened by about 10-15bp, and the euro fell at one point to $1.2624, and ¥97.04, the lowest value since 2000.
ECB Governing Council member Ewald Nowotny said Standard & Poor’s downgrades of euro members was based on the ratings company’s favouring the Federal Reserve’s policy of buying government bonds over the ECB’s “restrictive” policy, according to Bloomberg.
PSI+ talk breakdown on Friday
As if the downgrades were not enough, the news that talks on the PSI broke down on Friday sparked fears among investors. Kathimerini reported that the breakdown following a dispute about the interest rate levels and law that will apply to the new bonds. The IIF, the negotiating partner on behalf of the bondholders, issued a statement saying its proposal has “not produced a constructive consolidated response by all parties,…Under the circumstances, discussions with Greece and the official sector are paused for reflection on the benefits of a voluntary approach.” Reuters reports today that talks are expected to restart on Wednesday. The Greek government, meanwhile, is drafting legislation that would introduce collective action clauses (CACs) into bond contracts to ensure 100% participation in the debt swap. Government officials are also about to finalize a catchall bill of reforms, to be voted on by next Thursday.
Le Monde considers France to play in Europe’s second division now
In its front page editorial, Le Monde argues that S&P’s decision constitutes a sanction against French economic policy and particularly for Nicolas Sarkozy. „But the worst is elsewhere: in the division that S&P’s decision brings about, there are Europes in the eurozone. First, there is northern Europe, countries with rigor in their public accounts, and with strong growth potential. Germany, which has not been downgraded is at its core. And then there is southern Europe, whose states are in serious financial trouble with very modest growth prospects. Degraded along with Spain and Italy, France has become part of this second Europe.”
For Francois Holland France is now in the second league
Talking to Le Monde, Nicolas Sarkozy’s Socialist challenger said: „The worst is that our position in Europe has been weakened: We are the only ones with Austria to lose the triple A. It is the first time since countries are rated that France breaks away from Germany. We are no longer in the first division.“
Sarkozy wants to accelerate the reforms in France
Nicolas Sarkozy wants to take the downgrade as a trigger to accelerate economic reforms 100 days before the presidential elections, Le Figaro writes. Tomorrow he will receive the social partners for a long planned social summit. According to the paper, the president will mostly listen and announce any decisions. Towards the end of month he will do a TV interview, in which he will announce what he intends to do next. In his first public statement since the loss of the triple-A on Sunday, Sarkozy used the word „courage“ seven times to describe his attitude in the next few months. According to Les Echos, the president will push ahead with his plans to decrease labour cost by increasing the VAT as Germany did during Angela Merkel’s grand coalition in 2007. According to Le Journal du Dimanche, one option would be raise the VAT by 2pp.
PM Fillon asks Hollande to submit his economic plan to S&P
Reacting to the downgrade and Francois Hollande’s criticism, the French prime minister Francois Fillon asked the Socialist presidential candidate in an interview with Le Journal du Dimanche to submit his economic program to S&P. „It would be interesting to know what a rating agency thinks of a program that only includes increases of spending and tax hikes and, still worse, decisions turn back structural decisions like the pensions reform or the French nuclear policy“, Fillon said.
Germany wants to tame rating agencies and rewrite rules government bonds
As a result of the rating decisions Germany is in favour of rewriting the rules for ratings, Financial Times Deutschland reports. One option could be that banks and insurance companies could be forced to rely on their own ratings to decide whether or not to keep government bonds of certain countries. Currently many banks and insurers operate with rules that force them to sell bonds once rating agencies lower their rating. According to Angela Merkel, it is worth checking if new legislation could not provide to less dependence on rating decisions and the resulting negative feedback loops.
Germany’s debt level likely to lower that originally foreseen
The difference between Germany and France also increases in terms of budgetary policy, Frankfurter Allgemeine Zeitung writes. As a result of better than expected developments at Hypo Real Estate and WestLB, the German debt level in 2011 is likely to retroactively fall below 80%. It was originally seen at 81.7% but will now probably fall to 79%.
Frey on Austria’s need for a growth strategy – and the likelihood of this to happen
Eric Frey in Der Standard writes that the main reason for Austria’s downgrade are external – Hungary, Italy and the eurozone;
Austria can do nothing about it. To regain its triple A rating, simple fiscal consolidation will not be sufficient. Austria would need a sustainable growth strategy. Proposals for wealth taxes and a rise of the retirement age are on the table. But politically, it seems impossible to agree upon. The outcome of complex coalition talks will most likely be a minimalist compromise focussing on short-term savings programme that might calm down investors but will do nothing to get the triple-A rating back.
Depreciation condition for eurozone survival
Ricardo Caballero and Francesco Giavazzi argued in a comment for Bloomberg that a significant depreciation of the euro is the condition for the eurozone survival. 55% of Italian exports and more than 50% of Greece’s exports are are sold outside the euro area. A 15% euro exchange rate depreciation would give a big boost to their exports, and compensate for the contraction of domestic demand. The authors call on the ECB to cut interest rates to zero and pledge to keep them there for quite a while.” This must be done, not as a replacement for the drastic fiscal adjustments, but to make sure those measures are effective.”
Linde CEO Reitzle thinks Germany should leave the euro
Linde’s CEO Wolfgang Reitzle thinks Germany should leave the euro. Talking to Der Spiegel the CEO of the gas and engeneering group argued that further assistance for crisis countries decreased their incentive to reform. Instead of helping, Germany should leave the euro and form a separate currency bloc with similarly competitive Northern European countries. In the first few years the new currency would appreciate, exports would drop and unemployment would rise in Germany, Reitzle concedes. „Within 5 years already Germany could be even stronger in relation to its Asian competitors“, he said. He said this scenario, while not being his favourite one should not be declared taboo.
Wolfgang Munchau on the downgrade
In his FT column, Wolfgang Munchau writes that Friday’s news may not have been a surprise, but it is important because it reminds us of the mechanism of the eurozone’s unravelling – a process that has now started. Fiscal austerity augments the recession, which will lead to more downgrades, to which the European policy response is more recession. Another vicious circle could be triggered by a disorderly Greek default, which will immediately put pressure on Greece to quit the eurozone, which in turn would jeopardise Portugal.
10-Y Spreads, Forex, ZC Swaps and Ois-Libor
The French downgrade and the looming Greek bankruptcy have jolted financial market on Friday night. The euro is depreciating, and spreads have risen by 10-15bp – and all this despite the markets had anticipated those events perfectly.
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