By Win Thin
S&P cut Portugal one notch from BBB to BBB-, and comes just five days after it cut the rating from A- to BBB. Did things really materially change over the past five days? It’s time for a reminder of what the agencies are capable of doing when they have been caught behind the curve. Indeed, we haven’t seen them flailing this badly since the Asian crisis, when S&P took Korea down by four notches on December 22, 1997 from BBB- to B+. And that was after a three notch downgrade just eleven days earlier from A- to BBB-, a two notch downgrade on November 25 from A+ to A-, and a one notch downgrade a month before that on October 24 from AA- to A+. That’s total of ten notches over the course of two months. It wasn’t just S&P, as Fitch took Korea from AA- down to B- (twelve notches) over the course of one month in 1997, including a six notch move on December 23 1997. To us, the Asian crisis was when the credibility of the ratings agencies went out the window, as investors found out painfully just how far off the agencies had really been. What’s worse, both S&P and Fitch turned right around and put Korea back to investment grade BBB- in January 1999, a little over a year later. Really? Country creditworthiness changes largely over time, not overnight, and so it is simply inconceivable that a country like Korea could be marked down and then up by so much so quickly.
Fast forward fourteen years and here we are again. Rating agencies totally missed the boat on the peripheral euro zone, and are now trying to play catch up and perhaps even overcompensate to the downside. We note that S&P also cut Greece by two notches from BB+ to BB-, and that negative outlooks were kept on both today so further downgrades appear likely. As such, we predict more flailing and more downgrades ahead. The FX market has become largely immune to the downgrades, with the euro hardly reacting at all to recent downgrade news. This is likely to hold as long as markets have confidence in Spain. However, peripheral bond and CDS have been impacted by the downgrades. We note that regardless of what the agencies do, the fundamental backdrop for the periphery will continue to worsen this year. As noted earlier, Portugal is marking down growth forecasts, and with borrowing costs still high and rising for the periphery, the debt ratios are likely to worsen through next year at least.
