THE downgrades of France and Austria on Friday followed by yesterday’s walloping of the European Financial Support Facility (EFSF) may have been widely anticipated, but that does not mean that they are irrelevant. After all, analysts have predicted the timings of seven of the last three sovereign downgrades. But more than anything this latest move from Standard and Poor’s is embarrassing for French President Nicolas Sarkozy and for European policy makers. “It is easy to say that these downgrades were already ‘priced’ by the bond markets. That doesn’t stop the embarrassment factor for, in particular, the French and Austrian administrations,” says Dan Ison, European equities fund manager at Threadneedle. “Could this mean the end of the ‘Merkozy’ love-in we have seen over the past few months? Sarkozy has an election to fight in May, and it is difficult to argue that France and Germany are equal at this stage of the crisis (if they ever were).”
Though Moody’s yesterday ran contrary to S&P by reaffirming France’s AAA-rating, France risks being pushed out of the club of what are considered to be strong core European sovereigns and into the wilderness of the problem countries.
DWINDLING FINANCIAL SUPPORT
With the demise of France’s top rung sovereign rating, the downgrade of the EFSF was never going to be far behind. On the announcement of the downgrade, S&P stated that: “The EFSF’s obligations are no longer fully supported either by guarantees from EFSF members rated AAA by Standard & Poor’s, or by AAA-rated securities.” The ratings agency added: “We consider that credit enhancements sufficient to offset what we view as the reduced creditworthiness of guarantors are currently not in place.”
The downgrade will increase the volumes of those calling for the Germans to allow the ECB to turn on the printing presses and become the European lender of last resort, but officials have so far resisted those demands. ECB chief Mario Draghi, speaking in his capacity as head of the European Systemic Risk Board (ESRB), continued his support for the Long-Term Financial Operation (LTRO), though this is seen by many as quantitative easing by the back door. Additionally, we have only seen a small percentage of the reported €480bn borrowed during the LTRO window in December deployed. The idea was that, if this money is used to buy back sovereign debt below par, it will have the effect of deleveraging and effectively raising bank capital. However, as Dan Ison points out, the latest downgrade puts this at risk: “The danger is that the European banking system, fearing a banking crisis, hoards that capital in order to maintain liquidity and does not do the quasi QE.”
NOWHERE ELSE TO GO
S&P originally put 15 EU members on credit watch negative on 5 December, days before a key European summit. But as Louise Cooper, markets analyst at BGC Partners points out, most European equities markets have rallied since then – on 5 December, the FTSE closed at 5,567 (currently 5,657), the DAX closed at 6106 (currently 6,220) and the CAC closed at 3201 (currently 3,225). “Does this mean that ratings agencies are behind the curve and irrelevant? Or does it just show the resilience of equities in the face of pretty dire developments?” asks Cooper. “Although markets do move faster than ratings agencies, I would favour the second view.” With so few places to put your money in these dire economic times, don’t be surprised to see a repeat performance this time around.