Fitch, the ratings agency, has decided enough is enough and has downgraded Greece to BBB-. This is still investment grade despite obvious signs that Greece is no longer an investment grade risk. Not only are the Greeks now (unsuccessfully) marketing their bonds in the US as an emerging market play, the yield on Greek debt is now well above many other countries that are rated non-investment grade.
This downgrade is inevitable, as I indicated in February when the Greek banks were downgraded.
So you see, the Greek government’s anticipated budget cuts, ‘fiscal austerity’ will affect the real economy, which in turn decreases demand for credit and weakens the banking sector. The lower demand for credit, in turn, further weakens the real economy. Anticipating all of this, the ratings agencies pile on, downgrading the banks, increasing their cost of capital. And on it goes. Let’s not forget the capital flight we are now seeing either. That has to weaken Greek banks.
Here’s my question: when does this affect the Greek sovereign credit rating? That has to be next because the scenario I just scoped out would indeed suggest lower tax revenue and more budgetary pressure.
Sure sounds like a death spiral to me.
My assumption is that this is going to get worse. Brown Brothers Harriman’s Win Thin says:
Showing impeccable timing, Fitch just downgraded Greece two notches to BBB- and maintained a negative outlook. This is the lowest investment grade rating, and one more would put Greece in junk territory. Fitch has been the most aggressive, and was the first to cut Greece to BBB+ back in Dec. S&P followed suit in March, but Moody’s inexplicably still has Greece at A2 (equivalent to A). This is a very aggressive move by Fitch, as our model shows Greece at BBB/Baa2 but clearly, the situation remains very fluid.
As EM watchers know, countries can get caught up in a vicious circle whereby market skepticism (which leads to higher borrowing costs) actually ends up pushing that country over the edge of the abyss. The Europeans appear to have really missed the boat on this one up big time. A big, timely rescue package with an announcement shock effect was needed and they didn’t deliver. We’ve seen this in EM crises in the past. When officials get cute and try to muddle through, markets will test them. Meanwhile, EM policy-makers are thinking, how did you developed world guys mess this up so badly? We think the EU should have asked Brazil, Korea, and others in EM on how to stabilize market sentiment when sovereign risks are rising. And as long-time EM observers, we would NEVER, ever underestimate the threat of contagion.
These guys know their emerging market, so watch for signs that contagion increases with Greece now downgraded to near-junk.
Here are my questions:
- Who has been selling Greek sovereign CDS? The rumour is that German Landesbanks and AIG had done while CDS spreads were low. I guarantee you a default will be a huge problem for CDS market. Why aren’t we hearing about collateral problems due to the vaulting CDS spreads of Greece?
- The Greek yield curve is inverted from 3M to 5YR. There’s no way they can sell 6 and 12 mo. bills next week in this case. It would seem the end is nigh unless someone pulls a rabbit out of the hat at the weekend. IS there any chatter about what happens if Greece can’t get these funds?
Anyway you look at it, the chances of another panic are increasing. Not to worry though. In America, Dow 11,000 is coming, retail sales are up by decade high percentages, and happy days are here again.
Originally published at Credit Writedowns and reproduced here with the author’s permission.
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