By Win Thin
With the US downgrade now out of the way, we think market attention will swing back to other DM countries that are facing downward pressure on ratings too. Here is a summary of our most recent ratings outlooks for DM.
Our model has the US as a weak AAA/Aaa/AAA credit, and we did not think that the downgrade was entirely justified on fundamental grounds. Our model gives the US score a small boost due to the dollar’s standing as the world’s reserve currency. Taking that out drops the US down to AA+/Aa1/AA+, but at this juncture, we see no end to the dollar’s premiere status. However, now that the move has been made, it brings into question other AAA ratings.
The UK has to us long been a candidate for downgrades, as our model has it as AA/Aa2/AA vs. actual ratings of AAA/Aaa/AAA. S&P had the UK on credit watch negative during the financial crisis, but took it off last year after the incoming Tory government instituted fiscal tightening. With growth prospects dimming, we think the agencies will take another look at the UK’s AAA standing and start to talk about downgrades.
The next weakest AAA credit is France, which has slipped into AA+/Aa1/AA+ territory. By most metrics, France is a weaker credit than the US, and so we think agencies will have to reassess this AAA/Aaa/AAA rating as well. The recent move to downgrade some French banks due to heavy exposure to Greece is likely a warning shot that will be followed up with sovereign pressures in the future.
Belgium has AA/Aa2/AA status in our model, below its AA+/Aa1/AA+ actual ratings. Being without a government for over a year surely qualifies Belgium for a downgrade, since S&P took pains to note that the broken political process in the US was a factor in its downgrade. If any of these three non-peripheral European countries come under downgrade pressure, the euro zone debt crisis will have moved into a totally different (and more worrisome) phase. With global growth rolling over, we think it is only a matter of time before these three are downgraded.
Moody’s recently cited the BOJ’s failed FX intervention attempt and the stronger yen as potential for another rating cut on Japan. We do not agree with that rationale, but our model does point to downgrade risks for other fundamental reasons. We view Japan as A+/A1/A+ compared to actual ratings of AA-/Aa2/AA. Fitch in particular looks out of line.
A word about the euro zone periphery. We continue to believe that Spain, Italy, Ireland, and Portugal are all still facing significant downgrade risk. Only Greece at CC/Ca/CCC is close to correctly rated. And with euro zone growth slowing, these peripheral countries are likely to be downgraded too.
Lastly, we note that the supply of true AAA credits is dwindling. In Europe, there is still Germany, but we believe that as it takes on more and more countries to backstop, Germany’s debt ratios and fundamentals will deteriorate too. Now, it is a solid AAA credit, but the future is not so bright. The dollar bloc, the Scandinavian countries, and Switzerland are left as very solid AAA countries, along with the Netherlands and Luxembourg. But taken together, these countries are a very small slice of global GDP and so investors have few options with regards to AAA safe havens.
Source: Bloomberg, BBH