Vendredi le Treizième

by CC January 13, 2012 12:05 pm • Commentary

With the rumors flying around about S&P’s downgrades of several Euro countries, it’s time to put them all together and try to figure out what it means. Here’s a round-up from the WSJ:

Because the rumors and headlines are flying hot and heavy right now, here’s a quick roundup of where we think we stand, if you can call something based on rumors and headlines “standing:”

(Please take with a large lick of salt)

France will only be downgraded by one notch, not two.

Austria will be downgraded by one notch.

Germany will not be downgraded. As the FT writes, with France and Austria downgraded, Germany will be the only AAA-rated nation backing the EFSF bailout fund.

The Netherlands, Finland and Luxembourg will also not be downgraded, keeping their AAA rating.

There are also rumors that Italy, Spain and Belgium will also be downgraded, though there are questions about Italy.

The idea of a mere one-notch downgrade for France seems to have bolstered market confidence a good bit.

So what does all this mean? The main concerns here are in the stability of the EFSF and its ability to leverage. From the Fiscal Times:

A downgrade could automatically require some investment funds to sell bonds of affected states, making those countries’ borrowing costs rise still further.

“It’s been priced in for several weeks, but the market had been lulled into complacency over the holidays, and the new year began with a bounce in risk appetite, thanks partly to a good Spanish auction,” said Samarjit Shankar, Director Of Global Fx Strategy at BNY Mellon in Boston.

“But the Italian auction brought us back to earth and now we face the spectre of further downgrades.”

Italy’s three-year debt costs fell below 5 percent on Friday but its first bond sale of the year failed to match the success of a Spanish auction the previous day, reflecting the heavy refinancing load Rome faces over the next three months.

So far the markets have taken this news in stride, the Euro is down, and European markets are also. But not a ton. Many think the market has already priced in this downgrade, and also the initial worry was that France would be downgraded 2 notches when now it only looks like it will be one notch. But some worry things are a little more complicated than that. The WSJ gathered some recent commentary on what downgrades mean to the European situation:

But contrary to what many people think. The market is not an all-seeing, all-knowing organism. It’s not a crystal ball. It cannot tell the future. There are still a few things that we don’t know about what would happen if important AAA European countries lose their AAA status. Here are a few things to think about, culled from recent notes on the subject.

Nikolaos Panigirtzoglou, J.P. Morgan: In repo markets the major risk from AAA country downgrades is with tri-party repo agreements. As we argued before, a large part of tri-party agreements in Europe are classified first by rating, then by type of issuer and then by country of issue. So a tri-party agreement that currently takes French government bonds as collateral, would have AAA accepted, then Sovereign issuers and then France. If France no longer had the minimum AAA rating (Euroclear defines the rating as the lowest of the two, Moody’s and S&P), French government bonds would not be eligible anymore.

How big is the tri-party repo universe? According to ICMA’s repo survey, European tri-party repo is a €340bn universe. Of that, around half or €170bn is with AAA collateral. Of that €170bn, Germany accounts for around €70bn, France for €30bn and UK for another €30bn. So if France is downgraded, around €30bn of tri-party repos will be affected. Admittedly, this represents an upper bound of the amount of repos that are likely to be immediately affected, as not all tri-party agreements have strict AAA requirements.

Hans Lorenzen, Citigroup: We are not too worried about the conclusion of S&P’s review of European sovereigns. Downgrades in many countries and negative outlooks across the board are widely expected. With emphasis much more on the ECB than the EFSF these days, AAA ratings matter much less. If France (against our expectations) were to be downgraded by two notches we might see a negative reaction temporarily. A downgrade of Germany (against our expectations) would perhaps fray some nerves, but to our minds keeping the current AAA sovereigns in the same boat together would actually be preferable to divergences, which might fuel political tensions.

Jennifer McKeown, Capital Economics: A [French] downgrade could have at least three serious implications for the euro-zone as a whole. For a start, it could further reduce the lending capacity of the EFSF, which is currently matched by guarantees from AAA-rated euro-zone governments. (For more on this point in particular, see the Update sent to clients of our European service on Monday.) A second and perhaps even more serious implication of a French downgrade might be a rise in anti-euro sentiment in the region’s second largest economy. The French public’s disillusionment with the euro is already evident in the polls and in the recent increase in popularity of the National Front. Third, the loss of France’s top notch credit rating would, at the very least, confirm that steps towards fiscal union will be difficult to take and could be extremely costly for the core. At worst, it would highlight the risk that some of the euro-zone’s strongest economies might yet opt to leave the single currency area.

Jose Wynne, Barclays Capital: The implications of a massive credit downgrade of European sovereigns would also trigger revisions to the EFSF, corporates, and, more importantly, domestic banks. Downgrades would likely increase haircuts on collateral posting and accelerate deleveraging in the middle of a credit crunch. How much is still unclear, but these announcements are undoubtedly negative.

So, no one can agree, although everyone seems to agree it does have potential to damage the EFSF’s lending capacity. Whatever happens in France we can all agree that Carla Bruni will keep her triple-A rating. Meanwhile, over in Greece, those austerity cuts in the middle of a recession aren’t working out so great in reducing their debt stress (who coulda known?!)

Greece’s state budget deficit in 2011 widened to 21.64 billion euros compared with 21.46 billion euros a year earlier, according to preliminary figures released by e-mail from the Athens-based Finance Ministry today. The figure beat a target of 21.71 billion euros in the 2012 budget.

Ordinary budget revenue declined 1.7 percent to 50 billion euros while spending rose 2.8 percent, or by 1.9 billion euros, the e-mail said.

Economics is hard. So today we hear about Greek debt deals collapsing. From Reuters:

Talks between Greece and its creditor banks aimed at avoiding a disorderly default broke down on Friday, with Greeks warning of disastrous results if a bond swap deal is not reached soon.

Athens needs an agreement, effectively seeing creditors voluntarily giving up a lot of their promised returns, to slash its debt to more sustainable levels and convince the European Union and International Monetary Fund to keep lending it cash.

In what some analysts said may be a high stakes poker game at the last stretch of intense negotiations to convince private bond holders to voluntarily take some losses to avoid the worst, both sides appeared to be digging in their heels.

A Greek default would be far worse for both Greece and the banks than reaching some form of deal.

“Discussions with Greece and the official sector are paused for reflection,” said the Institute of International Finance (IIF), which leads talks for private bond holders.

“Unfortunately, despite the efforts of Greece’s leadership, the proposal put forward … has not produced a constructive consolidated response by all parties.”

Greek debt swap negotiators said earlier they were less optimistic about reaching an agreement to avert a disorderly default, warning failure to reach a deal would be disastrous for Greece and Europe.

“Yesterday we were cautious and confident. Today we are less optimistic,” said a source close to the Greek task force team in charge of negotiations.

“It is important to remind all parties that the consequences of failure would be catastrophic for Greece and the Greek people, Europe and Europeans,” the source said on condition of anonymity.

Some analysts said the statements may reflect negotiating tactics by both sides in the final stretch of the race to clinch a deal.

“I’m sure that’s exactly what it is. You have a situation where there was an initial agreement to write off at one level, then it’s a write-off at a higher level and I’m sure there’s some people looking at it saying we can get a better deal,” said Gary Jenkins, director of Swordfish Research.

“When you’re dealing with a sovereign, you don’t have a huge amount of tricks up your sleeve, because if they choose not to pay you there’s not an awful lot you can do,” he added.

I know what I would do if I was Greece. LEAVE THE EURO. But that doesn’t seem to be on the table. So this is all probably negotiation tactics. We’ll find out about these downgrades at 3pm ET apparently (time updated below.) Until then keep an eye on European bank stocks (which are well off their morning lows) and the usual Euromess indicators.


Update: French papers are saying the announcement may not come until a later time tonight, which will probably mean after the US markets are closed. This makes more sense actually, these ratings agencies tend to do this as a Friday evening news dump, not during market hours. My guess would be 4:30ish ET.