Standard & Poor’s downgrade of France’s credit rating was apparently an accident – so consider the reaction to the panicky downgrade as a kind of dress rehearsal: It lets you know how markets will react if and when an actual downgrade goes through. The way things are going for Europe’s sovereign-debt crisis, an actual downgrade looks more than likely.
According to Bloomberg News, S&P put out a message to subscribers at 3:57 p.m., Paris-time (or 9:57 a.m Eastern Time) suggesting that France had lost its triple-A credit rating. That was followed one hour and forty-three minutes later by a correction, affirming the rating.
All’s well that ends well? Not exactly. When markets learned of the downgrade, European stocks fell, while French 10-year government bonds surged 28 basis points (or more than a quarter of a percentage point), to their highest level since July. The action reverberated elsewhere, too: The CBOE Volatility index jumped and the S&P 500 surrendered its early lead and briefly dipped into negative territory.
This wasn’t a flash crash, though the moves were pretty quick – and the S&P 500 recovered the lost ground some time later. S&P, of course, is taking flak for its erroneous message. But there is an important lesson for investors here: A credit downgrade for France is clearly not built into the bond or stock markets, and you can expect markets to react violently if an actual downgrade happens one day.
What are the odds of that? Just as Italy supplanted Greece as the euro zone’s biggest troubled spot this week, highlighted by the country’s surging bond yields, France has the makings of a troubled spot in-the-making. Bond yields there have also been rising, with the yield on the 10-year bond now sitting at 3.456 per cent after rising for four straight days. Germany’s 10-year government bond yields just 1.776 per cent, meaning that the spread between German and French yields has been rising into awkward territory -- a point made by Bespoke Investment Group earlier this week.
This may not be the last we hear about a French downgrade.
