France and Austria lost their top credit ratings in a string of downgrades that left Germany with the euro area’s only stable AAA grade as Standard & Poor’s warned that crisis-fighting efforts are still falling short.
France and Austria were cut one level to AA+ from AAA and face the risk of further reductions, the rating company said in Frankfurt late yesterday. While Finland, the Netherlands and Luxembourg kept their AAA ratings, they were put on negative outlook. Spain and Italy were also among the nine nations downgraded.
“In our view, the policy initiatives taken by European policy makers in recent weeks may be insufficient to fully address ongoing systemic stresses in the euro zone,” S&P said in a statement.
The first gauge of the report’s impact will come in two days when France sells as much as 8.7 billion euros ($11 billion) in bills. History shows yields may not rise much, at least initially. Ten-year yields for the nine sovereign borrowers that lost their AAA ratings between 1998 and the U.S.’s downgrade in August rose an average of two basis points in the following week, according to JPMorgan Chase & Co.
The yield on France ’s equivalent 10-year debt rose 3 basis points to 3.055 percent yesterday as news of the downgrade leaked. Italy’s 10-year yield climbed 1 basis point to 6.596 percent.
While S&P’s full announcement came after the close of trading in Europe, U.S. Treasuries rose, pushing yields to the lowest levels this year as investors sought the safety of U.S. government debt. Yields on 10-year notes fell six basis points, or 0.06 percentage point, to 1.87 percent at 5 p.m. New York time. They touched 1.83 percent, the lowest level since Dec. 20, according to Bloomberg Bond Trader prices. The benchmark 2 percent security maturing in November 2021 gained 16/32, or $5 per $1,000 face amount, to 101 6/32.
S&P acted at the end of a week in which signs grew that Europe’s woes may be cresting as borrowing costs fell, evidence of economic resilience emerged and the European Central Bank said it had quelled a credit crunch at banks.
“Perhaps this will now concentrate the minds of EU policy makers making them realize that no country is immune to being pulled down by the euro crisis,” said Sony Kapoor, managing director of policy advisory firm Re-Define in Brussels. “The downgrades have now been expected for weeks so this should blunt some of the impact they would otherwise have had.”
European leaders are still struggling to tame a crisis now in its third year and convince investors they can restore budget order. The French downgrade may make it harder for the euro region's bailout fund to raise money and Greece’s creditors yesterday suspended talks with its government having failed to agree about how much money investors will lose by swapping the nation’s bonds. That may increase the risk of the euro-area’s first sovereign default.
The euro yesterday fell to its weakest in 16 months against the dollar, declining to $1.2665. The yield on Germany’s benchmark 10-year bund fell seven basis points to 1.759 percent after touching a record low on earlier speculation that S&P would maintain the nation’s AAA rating.
Authorities have still to produce “a breakthrough of sufficient size and scope to fully address the euro-zone’s financial problems” and should stump up more resources and show greater flexibility, S&P said. Officials were also chastised for focusing too much on budget cuts which could prove “self defeating” as economic growth slows, it said.
The result is that refinancing costs for certain countries may remain “elevated” and credit availability and economic growth may fade, it said. It nevertheless praised the ECB’s decision to lower interest rates and aid banks for helping avert a collapse of market confidence.
Regional finance ministers sought to play down S&P’s shifts or turn them to their advantage as European leaders prepare to meet for the first time this year on Jan. 30.
“It’s not a catastrophe,” French Finance Minister Francois Baroin told France 2 television, noting his country now has the same rating as the U.S.
Wolfgang Schaeuble, his German counterpart, said the moves vindicated the decision by governments last month to bring forward a permanent bailout fund to this year from 2013 and strengthened his country’s determination to stabilize the euro region by instilling stricter budget discipline.
“We know that there’s uncertainty with respect to the euro area,” he told reporters in the northern German port city of Kiel.
The French and Austrian downgrades risk sapping the potency of the region’s current rescue program, which has a spending capacity of 440 billion euros ($558 billion). The European Financial Stability Facility, which is funding rescue packages for Greece, Ireland and Portugal partially with bond sales, owes its AAA rating to guarantees from the region’s top-rated nations. It is scheduled to sell up to 1.5 billion euros in 6-month bills next week.
The French downgrade and refusal by governments to provide more credit enhancements would still reduce the fund’s lending capacity by around a third to 293 billion euros, Trevor Cullinan, S&P’s director of sovereign ratings, said last month. It is scheduled to call for bids of up to 1.5 billion euros in 6-month bills on Jan. 16.
John Chambers, managing director of sovereign ratings at S&P, said in a Bloomberg Television interview in New York that the EFSF’s “rating rests on its guarantors, and particularly its triple-A guarantors.”
“It will be interesting to see what the strategy will be regarding the EFSF,” said David Schnautz, a fixed-income strategist at Commerzbank AG in London. Downgrades could “limit the volume of AAA rated EFSF paper that could be issued, or the EFSF could begin to issue non-AAA.”
Investors ignored S&P last year when it cut the U.S. to AA+ in August as the world's largest provider of credit analysis argued that the failure up to then of Democrats and Republicans to agree on budget cuts made the U.S. less creditworthy. Seven weeks after the downgrade, the yield on the benchmark U.S. government bond fell to a record 1.6714 percent.
One difference with the France is that the U.S. is prepared to print money, making it easier for the world's largest economy to pay its debts, while the European Central Bank is still refusing to countenance that option.
``The U.S. is still rightly seen as a safe haven,'' said Fredrik Erixon, director of the European Centre for International Political Economy in Brussels. ``The U.S. is a big liquid economy with a strong tradition of honoring its debts in modern time and a central bank pledged to taking action if needed. It’s different with France in the sense that they cannot rely on strong central bank policies.''
The impasse in Greece’s debt-swap talks comes three months since officials and creditors agreed to implement a 50 percent cut in the face value of the country’s debt, with a goal of paring Greek’s borrowings to 120 percent of gross domestic product by 2020. Unresolved is the coupon and maturity of the new bonds to determine the total losses for investors.
Discussions With Greece
Proposals put forward by a committee representing financial firms have “not produced a constructive consolidated response by all parties,” the Washington-based Institute of International Finance said in a statement yesterday. “Discussions with Greece and the official sector are paused for reflection on the benefits of a voluntary approach.”
The government said the two sides will reconvene discussions next week. European governments have been pushing for the Greek debt to carry a coupon of 4 percent, a person with direct knowledge of the negotiations said this week. Private bondholders said they would accept those terms for a period of time if they were able to get a bigger payout later as Greece’s economy recovered, the person said.
The Greek bond due October 2022 rose, pushing the yield six basis points lower to 34.36 percent at 5:20 p.m. London time. The price climbed to about 20.5 percent of face value.
The first ever French downgrade strikes a blow to President Nicolas Sarkozy’s bid for re-election after he sought to protect his government’s creditworthiness by announcing tax increases and spending cuts. He trails his main rival, Socialist Party candidate Francois Hollande, by about 14 points in voting intentions for the second round of the election in May, according to a BVA poll for Le Parisien published Jan. 9.
Prior to S&P’s announcement investors had eased the costs they were imposing on Italy and Spain to borrow, sparking speculation the worst of the crisis may be passing. ECB President Mario Draghi said on Jan. 12 the central bank had averted a serious credit shortage and economy is stabilizing with data showing rebounds in German exports and French business confidence.
“This decision could upset the positive developments we’ve seen in Europe in the last few weeks,” ECB Governing Council member Ewald Nowotny said. “That’s the most dangerous thing in my view.”