Posts tagged ‘credit ratings’

Dying Breed

Last month we looked at the various refuges available to investors in the event of market panic. One of our conclusions was that:

The most effective hedge against panic is government bonds (though only those seen as safe).

Since then, both the broad statement and the caveat would appear to have been proved. From the US through Europe to Japan, developed market equity indices lost between 6% and 10% of their value (in local currency terms) during May. Gold and silver suffered by similar amounts. And government bond yields in several countries reached record lows, with ten year issues in Europe and the US posting gains of 3.5-4.5%.

As for the caveat: well, the price of the ten year Spanish benchmark fell by over 5% last month. Spain is certainly not a country seen as “safe” at the moment – as yesterday’s downgrade by ratings company Fitch underlined.

In fact, since we last looked at government bond ratings around the world, those rated “AAA” (as near as it’s possible to get to risk free) have become even more of a dying breed. The eurozone, of course, saw France and Austria fall to AA+ at S&P back in January. Finland, Germany, Luxembourg and the Netherlands are the only AAA rated euro countries left – and even they were subject to “negative watch” until a few months ago.

Outside the zone, the AAA club includes Switzerland, the Scandinavian countries and the UK – though even here there is uncertainty. S&P downgraded the Isle of Man to AA+ last November, and of course Fitch reminded us all yesterday that (along with Moody’s) they see the mainland’s AAA rating as being at risk over the next year or two as well.

There has been less drama in other developed countries. Japan suffered a couple of downgrades, but in any event has not been a AAA debtor for many years. The same goes for New Zealand. Outside Europe – following last summer’s US downgrade, again courtesy of S&P – the only other members of the AAA club remain Canada, Australia, and Singapore.

And yet there is a limit to the importance of all this. If bond markets close to an economy with deficit funding or debt refinancing needs, that is a serious development with potentially grim consequences. But if credit ratings fall, bond yields remain affordable and markets stay open, it’s a different story.

So it is interesting that ten year US and UK government bonds yield less than Dutch ones, even though their ratings and / or outlooks are “officially” worse. And Japan’s low bond yields are notorious despite the slow deterioration in its credit ratings over the years. At the other end of the scale, Spanish bonds have sold off today – but not by much (the ten year bond yield is currently 6.19%, 0.15% higher than yesterday’s close). And in Ireland, which is still rated junk by Moody’s, the same five year bonds that reached yields of over 17% a few months ago have spent most of 2012 below 6%.

Of course it is hardly necessary in these nervous times to remark that ratings companies may simply be getting ahead of the game. Perhaps Spain will follow Portugal into bailout country, despite the protestations of its government to the contrary, its relatively low debt burden and the yet more unpalatable fiscal trajectory that it might subsequently face. But bond market reactions to some of the higher profile sovereign downgrades we have seen in recent months suggest that they might have lost some of their power – to surprise, or influence, or both.

After all, take a step back and there is something rather funny about seeing Fitch downgrade Spain because it has to stand behind its banking system. A few short years ago, the ratings industry was citing likely sovereign support as a reason for being positive on rating bank debt through the cycle (banks being, by coincidence, among the keenest issuers of debt and the ratings companies’ biggest clients). Moody’s notoriously upgraded the big Icelandic banks – Glitnir, Landsbanki and Kaupthing – from single A to Iceland’s then sovereign rating of AAA in February of 2007, just as the first signs of the subprime crisis were becoming visible over the Atlantic, on this very logic. Within two years they had all got their sovereign support – and defaulted anyway.

The desirability of owning paper issued by a dwindling band of “safe” governments is understandable in a crisis. In recent times, however, investors have clearly looked beyond credit ratings in betting where safety really lies. Perhaps the ratings companies’ agitated caution will prove more insightful than their pre-crisis complacency. What is certain is that AAA-rated sovereign borrowers aren’t the only ones who don’t like the idea of numbering a dying breed.

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08/06/2012 at 4:06 pm

Two Futures

Inevitably, all the talk is of Europe – again. The top five worldwide stories on the Bloomberg terminal this morning all concerned the latest summit proposals, pushing a dull tale about the Chinese economy into sixth place. To summarise the headlines:

  • The European Stability Mechanism (the eurozone-only bailout fund originally planned to succeed the current EU-wide European Financial Stability Facility in 2013) will begin operations in tandem with the EFSF subject to a €500bn ceiling next summer.
  • EU Central banks will commit to lending €200bn to the IMF in the event that it needs to be lent back to the eurozone, of which €150bn will come from the eurozone itself.
  • Private sector bondholders will not take losses in future bailouts (i.e. after agreement of the Greek restructuring).
  • Last, and most important: eurozone governments will enact a budgetary agreement which will restrict borrowing and be subject to supranational oversight.

There was a key disappointment in that sizeable government bond purchases by the ECB did not explicitly form part of the package, so market reaction has been muted. European equity markets made a positive start; peripheral bond markets yields are a touch higher, but only a touch and remain kilometres away from their recent highs; and currency markets are unchanged.

Short term developments could transform the picture, of course. The commitment to extend the IMF’s firepower might entice reserve-rich countries (read: “China”) to make similar commitments. On the other hand, the ratings companies are seeking ever more creative ways to compete for credibility while worsening the panic. S&P has threatened to cement its US rating debacle with a raft of eurozone sovereign downgrades. In reply, Moody’s zeroed in on the financial sector and downgraded some French banks this morning. Even Fitch played a clever oblique stroke last week by warning over the solvency of the UK (who’d have thought it?)

Ultimately, however, the only short term variable of real significance remains the bond market. It will determine whether EFSF, ESM or IMF firepower is sufficient. It will determine whether or not ratings companies have the power to upset the apple cart. And it will determine whether or not the eurozone states can muddle through to the key element of the summit: the prospective agreement of a new eurozone treaty by March 2012.

In the words of Daniel Hannan MEP, Conservative eurosceptic and blogger for the eurosceptic Telegraph:

A rival treaty organisation, predicated on common economic government, would become de facto the new forum for integration. One by one, political powers would pass from the EU to the eurozone until the EU became a shell, an amplified free trade area, a kind of EFTA-plus. Which, of course, would suit Britain very well indeed.

The sovereign debt crisis would have transformed the political landscape in Europe – arguably for the better, if you are a Continental believer in the euro (i.e. in the majority) or a British opponent of it (ditto). Economically, the eurozone could come to resemble Germany: a defensive, low-inflationary and low-deficit power with an unexciting trend rate of growth and a high level of regulation. The UK would have the freedom to resemble this picture rather less, for better or for worse.

In the context of the current drama this may seem small beer but at least it would be palatable. Consider a second future: closure of the euro periphery’s bond markets, Italian and Spanish distress, and global panic culminating in a wave of sovereign defaults and an economic contraction that would be especially pronounced in debtor (western) countries. In this case the political consequences could be chilling.

This fifth EU emergency summit will have failed to bring the crisis to a sudden halt. The next few months could be just as interesting as the last. But what it has done – assuming that we get there – is give us a glimpse of what the sunlit uplands will look like.

09/12/2011 at 10:31 am

State Of The Sovereigns

Sovereign ratings downgrades have been making headlines for some time this year, but Moody’s downgrade of Japan on Wednesday caused hardly a ripple. This was not a surprise: Japan has been on “negative outlook” with the ratings company since May, the downgrade was small in magnitude (only one notch), and the sovereign remains highly rated at Aa3 (Moody’s equivalent of AA-, where S&P has rated the country since the beginning of the year).

Despite the high level of public debt in Japan – about 200% of GDP and rising – the high rating is arguably justified. Public debt is locally held, interest rates are low, and Japan is a highly developed and prosperous economy with over $1trn in reserves.

Nonetheless, readers might find it interesting for purposes of comparison to take a short tour of sovereign debt ratings around the world.

Starting with Europe, an especially high profile area, the range is all-encompassing, from AAA-rated sovereigns (large, such as Germany and France, or small, such as Austria and Finland), to Greece, standing on the brink of default at CC and famously the lowest-rated sovereign borrower in the world. In the middle are grouped the central and eastern countries, with Slovenia at the top (and at AA more highly rated than Italy), through Poland (single A), Russia (BBB), Turkey (BB) and others to Soviet throwback Belarus (B-).

The Americas also cover a full range of ratings. After S&P’s downgrade of the US, Canada is the only pure AAA. The other significant north American economy is of course Mexico (BBB). South and central America and the islands are mostly borderline or sub-investment grade apart from more strongly rated Chile (AA- / A+) and the offshore havens Bermuda (AA) and the Caymans (AA-).

Skipping west to the Pacific Rim, the only unequivocal AAA is Singapore (Australia is rated AA+ at Fitch and S&P has its AAA under review). China, Hong Kong, Taiwan and South Korea are all strongly rated in the AA / A range. Malaysia (single A) and Thailand (BBB+) get investment grade ratings, but the other tigers don’t do quite so well: Indonesia (BB+), the Philippines (BB) and Vietnam (BB- / B+) all fall into speculative territory.

Continuing the journey into Asia there are no very highly rated sovereigns at all. Kazakhstan leads the pack at BBB, beating India (BBB-) into second place. Mongolia, Bangladesh, Pakistan and Sri Lanka are all sub investment grade.

Which leaves Africa and the Middle East. Again, there are no AAAs, but Saudi Arabia and a few of the other Gulf states sit in secure AA territory. The north African countries are rated pretty closely together in the BBB / BB area. Of the others, key economy South Africa is solidly investment grade at A- / BBB+, whereas the few other states that are rated mostly come in at single B (even regional giant Nigeria).

The extent to which the world’s richer countries have put their economic security at risk has attracted much attention of late, and rightly so. But at the same time, these ratings show how some poorer countries have been closing the gap on their developed peers.

The continuing challenge to traditional perceptions of developed vs. emerging market risk will present opportunities as well as threats.

26/08/2011 at 4:35 pm 1 comment


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