20th October 2011
The French finance minister is adamant that the country's triple-A rating was ‘indispensible', but is it? After much hoo-haa, the US has weathered its downgrade without a significant impact on its ability to borrow or cost of borrowing. Do credit ratings matter?
A French Downgrade?
As it was, the French warning was relatively weak – Moodys warned that it might change the outlook on its possibility of a downgrade, which in the scheme of things is quite a long way from a downgrade.
It hasn't yet made any difference to the currency, but that may be a quirk of the Euro.
François Baroin, the finance minister, has said that France will "do everything to avoid a downgrade" of the triple A rating, adding: "Of course it is difficult, but it is indispensable".
France's worries are not just over the cost of its debt – there is a credibility issue: Jean-Pierre Dumas points out on the FT site that the blind cannot lead the blind: "It is a demonstration of the necessity to respect a public debt ratio ceiling, France overlooked this iron law in a monetary union, now we have to pay the price "no room for manoeuvre".
Spain under review
The rating agencies have also had Spain in their sites. Moodys said: "Spain continues to be vulnerable to market stress and event risk.
Since placing the ratings under review in late July 2011, no credible resolution of the current sovereign debt crisis has emerged and it will in any event take time for confidence in the area's political cohesion and growth prospects to be fully restored.
In the meantime, Spain's large sovereign borrowing needs as well as the high external indebtedness of the Spanish banking and corporate sectors render it vulnerable to further funding stress."
However, few can have been unaware that Spain was under stress. It has been well-flagged in the CDS market for some time. Though it should be said that the CDS market is responsive as well as predictive.
Do ratings even matter?
As such, The Economist has questioned whether these rating agency assessments really matter. It issued this piece in response to the US downgrade: "Well, shares are off a little and borrowing costs are up a very little.
A downgrade might be messy and could generate some economic ripples, but it's not the kind of thing that's likely to tank the economy.
The White House and Congress should fear a default more than a downgrade. And they should certainly be more worried about the impact of an overzealous fiscal contraction than about S&P's judgment."
The comment that an increase in borrowing costs would ‘only' cost the US 1% of GDP drew some derision from the commentsphere, alexTheCentrist says: "Yes, looking at it in relative terms is important, but we are talking about 100 BILLION dollars. ONE HUNDRED BILLION. 100,000,000,000 dollars. And this a 100% self-inflicted wound; this huge amount of money may be lost for no other reason except certain politicians' intransigence."
Average Joe Investor
This article on Seeking Alpha argues coherently that the real impact is not to be felt in rising borrowing costs, but in sentiment. It says that ‘average Joes' do not know the real impact of a downgrade and: "the economy is comprised largely (95% or more) of average Joes.
The S&P downgrade, which raises the spectre of a US sovereign default, will tend to psychologically spur the average Joe toward risk-averse behaviour.
The average Joe investor may be more cautious about purchasing equities; the average Joe business may tend to be more cautions about investing and hiring; the average Joe consumer may be more cautious about spending, particularly on big-ticket items. All of this is bad for the economy and stock market going forward."
The Importance of Treasuries
Ed Fitzpatrick, fund manager US Fixed Income at Schroders agrees: "There are essentially no other markets which can provide the depth and liquidity of Treasuries, therefore there will be minimal detrimental impact to Treasury demand from the downgrade in the near-term.
The downgrade adds additional stresses on some entities but the potentially damaging impact is the cost it inflicts on consumer confidence, increased volatility and the ability of policy makers to respond through fiscal stimulus in the future."
But that is the US. Other countries, without the depth and liquidity of the US government bond market may feel more pain. Overall, downgrades do not tend to be predictive, but are instead a reaction to economic problems.
They will have an impact on sentiment, but they are likely to have been well-flagged in the CDS market, which in turn is closely watched by the debt markets. They should be a surprise to no-one.