- Many downgrades made in financial crisis haven't been reversed
- Portugal's record 1.5% bond yield belied its junk ratings
Nine months of quantitative easing have only widened the chasm between sovereign-bond yields and credit ratings across the euro area, and 2016 may bring more of the same.
While the European Central Bank’s 487 billion euros ($531 billion) in purchases of government securities this year has driven borrowing costs to record lows, there’s been little effect on ratings companies’ outlooks for the region’s most-indebted nations.
With low growth and political risks enduring, many downgrades made in the financial crisis still haven’t been reversed, and countries such as Portugal remain at the brink of losing the ratings status needed for QE eligibility.
“There’s still significant credit risk,” said Ed Parker, head of EMEA sovereigns at Fitch Ratings in London. Parker said ECB policy and a low inflation outlook get most of the credit for crushing borrowing costs. “There’s been some recovery going on in euro-zone periphery ratings, but more measured than what we’ve seen in bond yields.”
The disconnect is an indication of the wider challenges the region faces. While lower financing costs gave states breathing room to retool their economies and reduce social spending, pressure was taken off governments to quit the path of unsustainable budgets.
Portugal is emblematic. While its 10-year yield dropped to a record low of 1.51 percent in March, from more than 18 percent in 2012, the nation only has an investment-grade rating at one of four rating companies, the same as in 2012. The country’s inconclusive October election led to a minority Socialist-led government.
At the same time BlackRock Inc., Pacific Investment Management Co. and Prudential Financial Inc. all say debt from Europe’s peripheral nations -- those less-creditworthy borrowers such as Portugal, Italy and Greece -- are primed to excel on QE.
Bundesbank President Jens Weidmann said on Monday that low rates risk giving the illusion of debt sustainability. Since QE kicked off, the average yield on the region’s debt tumbled to a record 0.475 percent, and yields on about one-third of the area’s securities have slipped below zero. Since the average yield set a record low in March, it rebounded to 0.73 percent as of Monday.
The ECB’s QE plan, designed to boost inflation in the region, attracted investors to bonds of nations they had shunned during the debt crisis. Even so, with about 15 months left for the central bank to add a total of 1.5 trillion euros of fresh funds into the sovereign-debt market, the economic picture remains bleak.
The euro area is set to expand just 1.5 percent this year, according to forecasts compiled by Bloomberg, lagging even its growth at the height of the crisis in 2011. Inflation in the single-currency zone was at an annual 0.2 percent in November, hovering close to zero and far below the ECB’s target of just below 2 percent.
Investors often ignore rating-company decisions. In almost half the instances, yields on government bonds fall when a rating action by Moody’s and S&P suggests they should climb, or they increase even as a change signals a decline, according to data compiled in 2012 by Bloomberg on 314 upgrades, downgrades and outlook changes going back to the 1970s.
While euro-area yields disconnected from ratings, credit worthiness still remains important for sovereigns whose grade may be deemed too risky for their debt to be included in securities indexes of developed-market governments.
Eric Vanraes, who helps oversee about $2.8 billion at EI Sturdza Investment Funds in Geneva, says he bought Irish debt after it became investment grade.
“We were not authorized to buy Ireland because it was junk,” he said. “As soon as it was upgraded to investment grade, we bought Irish bonds.”
The year 2015 did see a number of upgrades across the euro region, including Ireland and Spain, but most ratings remain far below their pre-debt crisis levels. At Moody’s, only Austria, Estonia, Finland, Germany and the Netherlands remain at the same level as in 2008.
“We don’t really see a consistent creditworthiness trend upwards or downwards,” said Moody’s analyst Dietmar Hornung. “It’s really country specific. There’s no plausible scenario that would allow us to bring ratings of peripheral countries back to where they were prior to the crisis.”