Fisher Investments Editorial Staff

From the Eurozone Department

By, 10/20/2011

From the non-news-masquerading-as-news department, Moody’s downgraded Spain two notches from Aa2 to A1 (equivalent to A+), one notch below S&P and Fitch’s current ratings, both of which downgraded Spain earlier this month. Among the reasons given were the absence of a eurozone debt solution, poor growth prospects and difficulty meeting fiscal targets (none of which is especially new). They also mentioned the risk of a “confidence-driven funding crisis,” simultaneously noting the risk of Spanish default is still very low.

As we’ve mused before, why anyone pays much credence to ratings agencies at this point is beyond us. Not only is their track record rather poor when it comes to accurately assessing forward-looking creditworthiness (see US subprime debt, Ireland, Greece, etc.), but markets seem to pay little heed to their opinions (see Treasury rates in the wake of the US’s August downgrade).

But beyond that, there’s little reason to doubt the eurozone will continue taking the steps necessary to backstop struggling countries, regardless of what the ratings agencies may say. Recall: When Moody’s downgraded Portugal in July, ECB president Jean-Claude Trichet asserted they would continue lending against debt issued or guaranteed by Portugal’s government, despite general requirements debt be top-rated. And German Chancellor Angela Merkel publicly stated eurozone officials likely had a better feel for their own debt woes than ratings agencies.

We largely agree—eurozone officials to date (as said before) have demonstrated a willingness and an ability (though usually after much politicking and occasional feet-dragging) to address eurozone debt troubles. If that continues to hold true (as we believe likely), the likelihood this most recent Spanish downgrade—which in theory could create some balance-sheet difficulties for banks holding significant amounts of Spanish debt since their capital ratios could be weakened some—in the long run does much harm is slim.

From the largely-feckless-blame-speculators department, EU lawmakers approved legislation Tuesday preventing traders from buying credit default swaps (CDS) on government bonds unless they own either the corresponding sovereign debt or other assets whose prices move in tandem with it. The goal is preventing what some see as speculation—for example, buying insurance against Greek bonds’ default without holding Greek bonds themselves. Lawmakers also agreed on new powers for the EU securities regulator to ban equities short-selling in exceptional circumstances—though there appear to be some loopholes, including allowing individual countries to suspend the rules if they feel the ban will impede equity markets’ proper functioning.

While not terribly surprising given frequent recent discussions of such a move, it is the first instance of an EU-level directive. But in our view, it’s not likely to stem PIIGS speculation—markets likely find other ways to hedge risk—and may have some unintended detrimental effects. Like removing liquidity from an already fairly illiquid CDS market, interfering with free markets and encouraging those looking to speculate to use sovereign bond markets instead, which could further pressure the ECB to support yields.

Finally, from the continued-political-willingness-to-support-the-euro department, it seems the eurozone is inching toward a deal expanding the EFSF—though not by purchasing more eurozone countries’ sovereign bonds outright, but by essentially leveraging it. In other words, the EFSF would insure both public and private investors against the first 20% to 30% of losses, which would allow the EFSF to cover up to €1 trillion of bonds.

Though initially opposed to leveraging the EFSF, Germany’s indicated it’ll likely support such a plan, provided it doesn’t increase the size of its commitment—which leveraging it as proposed would avoid. Discussions which seemingly bode well for this weekend’s EU summit, though any agreed-upon plans are likely implemented slowly and deliberately, as all such eurozone measures have been thus far.

All told, a somewhat mixed bag in the continuing drama across the pond. But for the most part, in our view, encouraging in the sense the political will to find solutions seems to persist, despite the occasional hiccup.

Click here to rate this article:

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.


Get a weekly roundup of our market insights.Sign up for the MarketMinder email newsletter. Learn more.