Eurozone Contagion Moves On To France
Win Thin of Brown Brothers Harriman is out with a note, remarking on the Eurozone contagion now moving to the core. Questions about France and a potential ratings downgrade are now circulating. Thin says:
France is coming under the spotlight after rumors of a downgrade made the rounds today. This in turn may have been triggered an admission Monday by French Budget Minister Baroin that holding onto the AAA rating was a “tough objective.” He has since walked back that comment, but it’s clear nerves are frayed right now. French spreads and CDS prices did not move much today, but we note that French risk has been creeping higher of late. Our sovereign ratings model puts France as a borderline AAA/Aaa credit, so there is certainly a risk that France falls into AA/Aa territory in the coming quarters. However, we do not think there is an obvious case for a downgrade currently for France, which is more than we can say for many others in the euro zone. But recent ratings action underscores the fact that the agencies are on the warpath and unlikely to relent anytime soon and so even France is coming under market scrutiny.
Given that most of the peripheral countries remain overrated, the downgrade story will remain in play for most of 2010. We saw this during the Asian crisis, when the agencies got caught wrong-footed and then slashed ratings with abandon across the entire region just as the situation was deteriorating further, adding more fuel to the fire. As we wrote several months ago, “To be clear, our model has been highlighting significant downgrade risk for Portugal, Ireland, Greece, and Spain since June 2009. The problems facing these peripheral countries are nothing new, and these problems are also not likely to be solved over the near-term. As such, we expect continued pressure on the bonds of the periphery, which likely will continue to weigh on the euro as well.”
In my view, Eurozone risks are larger because you have greater liquidity risks than with sovereigns that issue debt in their own currency (see my remarks at the end of the Ray Dalio post). And from an economic standpoint, the risks of austerity are already evident as manufacturing growth is slowing in Europe as well as in China, leaving India and Brazil to pick up the slack.
Therefore, I expect that pressure will not just accrue to the Eurozone periphery but will come to infect the core as well. And we now see infighting over the ECB policy to counteract the crisis developing between the Germans and the French. As this crisis has dragged on, the acrimony now developing between countries makes a break up the Eurozone less of a outlier event. This is what I told Howard Green last Thursday on BNN (video clip here). My view is that the political pressure to keep the Euro intact will see the Eurozone through, though there may be a sovereign default. My co-panellist on BNN, Lord Abbett’s Milton Ezrati agreed.