Batten down the hatches. As you are no doubt aware by now, credit rating agency Standard & Poor’s downgraded nine eurozone sovereigns last Friday, based on an eminently sensible rationale: the competiveness imbalance between the core and periphery is as much as a threat to the single currency as the eurozone government debt mo untain.
The market reaction to date has been fairly muted. While the euro fell sharply agains the pound, yen and the dollar on Monday morning, government bond markets took the decision in their stride, European equity markets showed only small declines, while US markets are closed on Monday for Martin Luther King day.
But while traders have by-and-large taken the downgrades in their stride, S&P’s decision may nevertheless have severe ramifications.
According to market players, the downgrades could kick off the following:
- A reduction in the available pool of eurozone government bonds for collateral purposes.
- An acceleration in bank deleveraging due to negative sovereign-financial feedback loops.
- Undermining further the creditworthiness of the European Financial Stability Facility (EFSF) – which is designed to be backed by guarantees from AAA-rated eurozone governments.
- Elevating the eurozone break-up risk.
The impact on Central and Eastern Europe is, generally speaking, obvious: a bloodbath in Western European sovereign and bank finance markets will wreak havoc on the region given strong financial/trade links.
Here’s more from two astute observers of the region’s credit fortunes, as told to Emerging Markets.
Neil Shearing, chief emerging markets economist, Capital Economics
| "These downgrades are just a reflection of problems that have been building up for years. All these eurozone tensions were [inherent in the design of] the eurozone itself and these will continue until a radical shift in the institutional architecture takes place or the eurozone breaks up.
In this context, we are very bearish on Central and Eastern Europe, which will suffer disproportionately more from the flight to safety out of EM assets.
The other way of looking at it is through banking linkages. As Western European parent banks look to further shore up their capital bases, eastern European funding will dry up and to the extent to which we see a credit crunch, we could see a renewed banking crisis." |
In other words, a new Vienna agreement, anyone?
Michael Ganske, head of emerging markets research, Commerzbank
| "The ratings’ downgrades create more pressure on eurozone governments to try to tackle this crisis. What’s a big cause of concern is that the EFSF now has a ratings downgrade, as the credit quality of eurozone is deteriorating – fast.
By contrast, Eastern Europe has relatively better credit metrics but weak exports to Western Europe will affect the region negatively.
What I am also concerned about is new regulations this year that will force European banks to adopt a tier-1 capital ratio of 9%, which is a big threat to CEE credit supply, as banks look to meet capital requirements by shrinking their loan commitments – just look at Unicredit.
Secondly, the breakdown in talks between Greece and the Institute of International Finance [which represents most large private-sector holders of Greek debt], is a cause of big concern, since it elevates outright default risk.
On the positive side, a weaker euro – as result of risk aversion towards the eurozone – will be positive for German trade and make CEE currencies more attractive from a dollar or yen perspective, in particular.
But currency trades are momentum, volatility and sentiment-driven trades so a sharp deterioration in the euro will not be bullish for risk assets. " |
Much to digest then. All eyes this week will be peeled on primary government auctions in France, Italy and Spain, as well as China’s GDP figures due on Tuesday.
Further reading:
Here’s Why Downgrades of European Nations are Still Important – WSJ