Firstly thank you to those who sent good wishes about my recent spell of ill health. As you can imagine much of the recent news was something of a kill or cure tonic for someone like me and there is much for me to get my teeth into. I was deciding between a post on the (very important) consequences of what the US Federal Reserve has just decided to do and the implications of a recent statement by the next Governor of the Bank of England when Standard and Poor’s made up my mind for me! So the UK it is…
What have Standard and Poor’s said?
Standard & Poor’s Ratings Services today revised its outlook on the unsolicited long-term ratings on the United Kingdom to negative from stable. At the same time, we affirmed our ‘AAA/A-1+’ long- and short-term unsolicited sovereign credit ratings.
What does this mean?
It means that all three of the main credit ratings agencies have us on negative watch the consequences of which S&P kindly explain.
The negative outlook reflects our view of a one-in-three chance that we could lower the ratings in the next two years if the U.K.’s economic and fiscal performances weaken beyond our current expectations.
It also means that none of the main credit ratings agencies have the chutzpah to realise that the UK plainly is no longer a nation that deserves a AAA credit rating. Yes we have control of our currency and accordingly can always settle our debts in pounds sterling (freshly printed if need be). However this ignores the fact that these ratings are primarily for foreign investors who would need to transfer any investments out of a possibly depreciated sterling before they can spend/consume it.
Does S&P tell us anything really new?
The basic assessment does not as it is very similar too if marginally more grim than the one outlined last week in the Autumn Statement. However there are some points of note and let me begin with a rather breathtaking one.
along with the U.K.’s good inflation record
Really? Perhaps the word “good” needs to find its way into my financial lexicon..
Also the UK Office of National Statistics produces UK national debt figures which are not comparable to ones used abroad,for example in the Euro area, and the S&P statement highlights this with its numbers.
such slow recovery could result in net general government debt approaching 100% of GDP, by our calculations, from its current estimated level of 85% of GDP in 2012.
If I now give you the latest numbers from the ONS you will get the idea.
Public sector net debt was £1,068.8 billion at the end of October 2012, equivalent to 67.9% of gross domestic product (GDP).
Such differences have tripped up our national broadcaster quite a few times.
Does it matter if we lose our AAA rating?
Whilst there has been a political debate about this issue with both sides using it as a football they can kick, the truth on recent evidence is simply no. If we look back to the recent French downgrade which I discussed on the 22nd of November we see this.
Although the effect has been more perceived that real as the CAC 40 equity index has rallied all week and is now at 3492 and whilst her ten-year bond yield is up to 2.18% that has hardly put it in the stratosphere! Also if we look for international comparisons UK Gilt yields have risen by a similar amount.
So at best not much and if I now update you with the ten-year French bond yield which is 1.98% you can get the full picture. Her benchmark government bonds have risen and yields fallen so exactly the reverse effect that many media pundits will try and have you believe. If we go back to the early part of 2012 we saw a rather similar reaction in the United States govenrment bond market.
In other words on recent evidence the ratings agencies would be doing the UK a favour if they took away our AAA rating! Not quite what many expect is it?
Comparing the UK to France
We can also use the French ten-year bond yield in another way to measure the effect of the UK losing its AAA rating. If we compare her 1.98% to our 1.88% we can see that the gap or “spread” is relatively narrow right now. So an initial perusal might well make one conclude that we might expect our ten-year bond yield to rise by 0.1% and to not exceed 2% which hardly fulfils the claims of some of the doomsayers does it? After all the UK ten-year Gilt yield only passed 2% on the way down in early May of this year so rather than going off the edge of a cliff we would in fact perhaps be stepping back 7 months or so.
Actually markets can be forward thinking
The arguement that the UK losing its AAA credit rating would have a big impact has two other problems. Firstly if you take a look at what the UK Gilt market has been doing in recent times you see that overall it has been falling if we use the ten-year yield as a benchmark. On August the 2nd of this year it closed as low as 1.44% and late August saw another attempt to go lower but early-mid September saw quite a surge which at one point looked in danger of pushing us above 2% again although we only went as high as 1.97% on September 14th. So a more thoughtful reflection would be that if the UK Gilt market had an adjustment to make for the (expected) loss of our AAA rating it did so in early to mid September of this year.
What about Quantitative Easing?
Regular readers will be aware of my theme that due to intervention by both governments and central banks many markets are manipulated these days. The policy of Quantitative Easing or QE is in fact designed to manipulate markets by driving yields lower and prices higher. So far so good for its fans.
However whilst that is true in the initial stages there is some evidence now that once QE reaches the stage that I have described as “More,More,More” then the effect may turn the other way. For example we know this.
In July the MPC announced the purchase of a further £50bn to bring total assets purchases to £375 bn
And we know that every Monday,Tuesday and Wednesday (a new definition of the working week?) when Gilt prices were falling in September the Bank of England was there buying £1,000 million of Gilt stock. Yet my point is that yields still rose and they did so substantially.
So we see that the real reason why the media will probably not get what it wants when the UK loses its AAA rating is that it happened back in September. If we look at the evidence from recent downgrades we see that in fact one of my favourite economic papers (Rudiger Dorbusch on “overshooting”) may well be in evidence as usually markets then rally. This type of behaviour is summed up in a City phrase which is echoing in my ears as I type this.
Seen it,done it,reversed it
It was very kind of all those of you who contacted me about my recent illness with one even going to the trouble of putting a get well card through my door. As someone who often considers financial tail risk I am left considering health tail risk after stretching and twisting backwards to put up a new light fitting only to discover it has disturbed my inner ear. Anyway there is a musical theme for even this and I now hand over to Elvis Costello and the Attractions.
I can’t stand up for falling down
I can’t stand up for falling down