Standard & Poor’s To Eurozone: Fix It or Else… (VGK, EWI, EWG, EWP, EWQ)
The ratings agency said late Monday that it had put the credit of 15 Eurozone countries, including AAA-rated Germany, on a 90-day watch. The move means each affected country has 50% chance of a downgrade.
European leaders are scheduled to meet in Brussels Dec. 8 and 9 to discuss EU treaty changes that would mitigate the debt crisis, such as restrictions on budget deficits. German Chancellor Angela Merkel and French President Nicolas Sarkozy unveiled an outline of the plan Monday.
The timing of the S&P warning “could hold leaders’ feet to the fire and force them to go through with a comprehensive solution,” Peter Jankovskis, co-chief investment officer at OakBrook Investments, told Reuters.
Reaction of the world’s stock and bond markets was muted, with investors apparently looking ahead to the summit.
Money Morning Capital Waves Strategist Shah Gilani said it was “about time” the ratings agencies started to get serious about credit ratings in the Eurozone (NYSEARCA:VGK), saying they were behind the curve on such problems as mortgage-backed securities.
“Now they’re pushing their new “ahead of the tsunami’ PR campaign,” he said. “Their PR agenda aside, they’re right to be knocking these credits down to reality.”
They Had it Coming
S&P listed several reasons for its warning.
“After a good two years of trying to manage the crisis, the political efforts have not been able to arrest matters,” Moritz Kraemer, head of European sovereign ratings at S&P, told the Financial Times. “It is our view that this is a systemic stress, a confidence crisis that affects the Eurozone as a whole.”
Those “stresses” include tightening credit, rising government bond yields, squabbling among Eurozone leaders about how to cope with the crisis and the rising risk of a Eurozone recession next year.
“We are approaching a very important moment where the crisis could take a very significant turning point for the worse and we want to warn investors,” Kraemer told The FT. “Considering how the crisis has deepened and the challenges that they are facing, [the summit] is the last good opportunity that policymakers have.”
Although the S&P said it would take the results of this week’s summit into consideration, no one should doubt the agency’s resolve. This past summer S&P followed through on a similar threat to cut the credit rating of the United States to AA+ from AAA following the debt ceiling crisis debacle.
“S&P’s view is that the political outcome will also drive creditworthiness, and I don’t think anyone in their right mind would dispute this point,” Ashok Parameswaran, an emerging-markets analyst at Invesco Advisers Inc., told Bloomberg News.
More Turmoil Ahead
Should this week’s Eurozone summit fail to go far enough to please the S&P, the real fireworks will begin.
Lower credit ratings will push the bond yields of already-stressed nations even higher, which will further raise their cost of borrowing – one of the issues driving the crisis, as it will make rolling over existing debt more expensive.
It could also add to the credit woes of Europe’s major banks, which hold much of the debt from troubled Eurozone members Portugal, Ireland, Italy (NYSEARCA:EWI), Greece and Spain (NYSEARCA:EWP) (PIIGS).
But perhaps the darkest cloud created by the S&P warning is the threat to the region’s primary bailout fund, the $588 billion (440 billion-euro) European Financial Stability Facility (EFSF).
Downgrading any of the AAA-rated nations like France (NYSEARCA:EWQ) and Germany (NYSEARCA:EWG) that act as guarantors of the EFSF – especially Germany, the largest and most stable economy in the Eurozone – would undermine its ability to borrow the money it would need to fund more bailouts.
“That changes everything. The EFSF is 100% beholden to the creditworthiness of its backers,” said Money Morning’s Gilani, noting that bigger bailouts would require leverage dependent on the good credit of the guarantor nations. “That makes the EFSF a stump of its former expected over-leveraged prospective glory. That game is now over.”
Any damage to the ability of the EFSF to continue its role as a firewall against Eurozone nations in danger of default would put more pressure on the European Central Bank (ECB) to become the “lender of last resort,” a role it has persistently resisted.
For now, however, the markets appear to be banking on the notion that Europe’s leaders are well aware of the consequences of failure and thus will emerge from this week’s summit with a concrete plan for resolving the debt crisis.
Of course, the real question is whether this time will be any different.
“We’ve seen a pattern where there has been talk of an agreement, and when it comes down to the details there’s nothing substantial at all,” Oakbrook Investments’ Jankovskis told Reuters.
We’re in the midst of the greatest investing boom in almost 60 years. And rest assured – this boom is not about to end anytime soon. You see, the flattening of the world continues to spawn new markets worth trillions of dollars; new customers that measure in the billions; an insatiable global demand for basic resources that’s growing exponentially; and a technological revolution even in the most distant markets on the planet. And Money Morning is here to help investors profit handsomely on this seismic shift in the global economy. In fact, we believe this is where the only real fortunes will be made in the months and years to come.