Barings Investment update on S&P's European rating downgrades
Commenting on the recent European credit ratings downgrades by Standard and Poor's, Alan Wilde, Head of Fixed Income & Currency, Baring Asset Management, London said:
Credit ratings agency Standard & Poor's announced the decision to remove their top AAA rating from the sovereign debt of France and Austria on Friday, while retaining Germany's triple-A rating. The agency also downgraded the ratings for seven other Eurozone members, reflecting renewed concerns over the currency area's ability to avoid further serious problems over the coming months.
These changes were widely expected and came as little surprise to market participants. France did, however, retain the second-highest rating of AA+, against fears that it could have been moved two "notches" lower by S&P, and French bonds rallied slightly on the news. The Euro, by contrast, weakened on the news that nine member states of the currency union had been downgraded. From an investment perspective, we were already positioned in anticipation of this change for portfolios which invest in European sovereign debt.
On Tuesday morning, S&P also announced a downgrade to the credit rating of the European Financial Stability Fund, which is based on the sovereign rating of its guarantors. This will increase still further the cost of any injection of capital from the market. Now that it has happened, we are likely to see a degree of acceptance from the Eurozone authorities that a AA+ rating for the stability fund remains comparatively high given the downward trajectory of sovereign ratings.
Domestically, the change is probably most significant for France, still the second-largest economy in the Eurozone. As French officials have commented, the news is not welcome, but hardly a surprise. If this development helps to focus the minds of politicians to accelerate reform and agree plans to reduce fiscal deficits it may in fact provide a rallying point. We do not believe there are any immediate implications for French banks, which have already been downgraded by the rating agencies in recognition of reduced sovereign support. The downgrade may weigh more heavily on President Sarkozy who had made the defence of France's AAA status paramount. With elections looming, it is his credibility which is most damaged by this, in our view.
Over the short term, we think it is unlikely that the remaining AAA-members of the Eurozone will be asked to contribute more to the stability fund, not least because the German authorities are implacably opposed. The priority is therefore likely to become speeding up the resolution process which started in December with the fiscal compact, and continue to try to resolve the disputes around the extent to which private sector investors will need to share the pain in Greece. The introduction of the Eurozone stability mechanism, due to provide additional support from July 2012, may even be brought forward.
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