Core Euro Zone Coming Under Increased Scrutiny
France is coming under growing scrutiny, though we note that the Bloomberg story regarding the potential loss of its AAA rating is based on analyst views, not rating agencies. Note that the rot continues to spread from the periphery to the core, with France 5-year CDS price of 104 bp today near the record high of 107 bp earlier this month while Belgium 5-year CDS price of 213 bp today is a new record high. Even Germany and Netherlands CDS prices have been dragged higher in recent weeks and what’s worrisome is that the core euro zone is coming under pressures as the contagion continues unabated. European officials have yet to find the “game-changer” that turns market sentiment around, and so we see continued spread-widening in euro zone bond markets as well as ongoing EUR weakness. We believe that the “game-changer” remains debt restructuring coupled with aggressive IMF and World Bank-backed structural reforms, a la Latin America under the Brady Plan. See our recent Special FX entitled “Handicapping European End Game Scenarios.” A muddle-through approach is clearly doing nothing to stop the bleeding.
Our sovereign ratings model puts France as a borderline AA+/Aa1/AA+ credit, so there is certainly a risk that France is downgraded from its current AAA/Aaa/AAA ratings in the coming quarters. However, because the slippage is borderline, 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 in the euro zone underscores the fact that the agencies are on the warpath and unlikely to relent anytime soon and so even France is coming under increased downgrade risk. As we noted earlier this month, euro zone fiscal and budget numbers are going to get worse before they get better and so the downgrade story is likely to remain intact for 2011.