Credit rating downgrades sure don’t pack the punch they used to.
Moody’s Investors Service cut its ratings on Italy, Spain, Slovakia, Slovenia, Portugal and Malta Monday evening, and issued warnings of possible future downgrades for Britain, France and Austria. Rather than fireworks, the action caused only modest ripples Tuesday across global trading in stocks, bonds and currencies.
Stocks did sell off in afternoon trading, when the S&P/TSX composite index flirted with a triple digit loss, but the move came after news that euro zone finance ministers wouldn’t be meeting today to discuss Greece’s latest aid package. Stocks recovered late in the session and the Toronto market closed with a modest loss of 44 points, to 12,354, while shares were little changed in New York.
It’s a huge change in market psychology. Last year, markets had freak-outs in response to sovereign credit downgrades, or even hints that ratings would be lowered.
“If this was about three months ago, they would have shocked everybody and we would have had a much different reaction,” observed Andrew Busch, a Chicago-based currency and public policy strategist at Bank of Montreal.
Some of Moody’s credit-rating moves had already been anticipated by markets, after rival Standard and Poor’s stripped France of its coveted triple-A status last month, a cut Moody’s chose not to emulate. It left France at triple-A but lowered the country credit outlook to “negative” – essentially a warning that a future downgrade is a possibility.
Where Moody’s did surprise was in its treatment of Britain. While leaving the U.K. at triple-A, it changed the outlook to “negative,” a sign that the country’s economic fundamentals could deteriorate to the point it would no longer qualify for the highest credit rating. It also slapped a negative outlook on the Bank of England’s triple-A rating.
The action on Britain “is probably the biggest take away,” said Camilla Sutton, chief currency strategist at Scotia Capital. “Any threat to that triple-A rating is a significant impact.”
Moody’s took that action because of worries over slower British growth, which will make it more difficult for the country to bring its heavy debt burden on a downward trajectory.
“The U.K.’s outstanding debt places it amongst the most heavily indebted of its triple-A rated peers, alongside the United States and France, whose triple-A ratings also carry a negative outlook,” Moody’s said.
However, the credit rating firm allowed that the U.K. had some breathing space on its rating, and a cut wouldn’t happen unless the country’s deficit fails to stabilize within the next three to four years.
For now, most traders are giving the U.K. the benefit of the doubt, saying it would take a substantial deterioration in the European economy for contagion to spread to London.
“If we saw Greece, Italy, Spain, if they all started to go, the U.K. [would] likely join that party,” Mr. Busch said.
One explanation for markets not reacting much to Moody’s downgrades is that conditions in Europe have improved markedly since late last year. The European Central Bank has managed to stabilize the banking system by offering huge amounts of funding to banks under its Long Term Refinancing Operations (LTRO) program.
The first injection of cash took place in December, and since then fears over a banking panic have subsided. Another cash injection under the program is scheduled for the end of February.
Fears that a messy Greek default would spread to other countries have also subsided.
The LTRO “is working extraordinarily well,” Mr. Busch said.
If there are going to be market-moving worries on the debt-rating front coming up, they will probably be from the United States.
S&P booted the U.S. out of the coveted triple-A club last summer. Both Moody’s and Fitch Ratings have maintained it at triple-A, but with a negative outlook, as the U.S. faces its fourth year of budget deficits at around the $1-trillion (U.S.) mark.
Mr. Busch said he’s worried that the lack of action in Washington, by Republicans and Democrats alike, in confronting the deficit could mean trouble ahead. “Given the lack of bipartisan leadership or lack of any leadership on both sides of the aisle, it really sets itself up for a train wreck by the end of this year.”
Moody's announced ratings actions for nine EU countries, citing “their susceptibility to the growing financial and macroeconomic risks emanating from the euro area crisis.”
Britain: Outlook on triple-A rating changed to negative
France: Outlook on triple-A rating changed to negative
Italy: Downgraded to A3 from A2, negative outlook
Portugal: Downgraded to Ba3 from Ba2, negative outlook
Spain: Downgraded to A3 from A1, negative outlook
Austria: Outlook on triple-A rating changed to negative
Slovakia: Downgraded to A2 from A1, negative outlook
Slovenia: Downgraded to A2 from A1, negative outlook
Malta: Downgraded to A3 from A2, negative outlook