France will feel the impact of USAA+ | FT Alphaville

France will feel the impact of USAA+

Where will the impact of the of the USAA+ downgrade be felt most? The US or Europe?

Europe, of course, reckons Gary Jenkins of Evolution Securities.

So why might the impact be felt more strongly in Europe? Well, now that S&P no longer rates the US at the highest level they may start to look more carefully at other AAA rated sovereigns. With the turmoil in Europe there have been many politicians suggesting that the size of the EFSF has to be increased. But any suggestion that the EU is turning into a Fiscal Union (even if by default) could well have an impact on individual sovereigns’ ratings as well as the EFSF /ESM structure.

And nowhere more so than France, where debt to GDP (let us not forget) is estimated to reach 85-95 per cent by 2013, depending on fiscal reforms, interest rates and growth, but not counting contingent liabilities from the EFSF.

Indeed, that point has not been lost on other commentators. Pimco’s Mohamed El-Erian:

It is hard to imagine that, having downgraded the US, S&P will not follow suit on at least one of the other members of the dwindling club of sovereign AAAs. If this were to materialise and involve a country like France, for example, it could complicate the already fragile efforts by Europe to rescue countries in its periphery.


Of course, it’s worth pointing out here that S&P affirmed France’s rating over the weekend and there was a very specific reason for the USAA+ downgrade — the dysfunctional political system. However, the figures on French GDP/debt speak for themselves, particularly in light of an extra eurozone bailout contributions.

Anyway, the task facing the ECB is difficult enough as it is. They are going to have to buy enough Italian and Spanish bonds at a yield level that encourages others to buy in alongside.

Gary Jenkins again:

That’s a tough trick to pull off because if the market is not confident of ultimate full repayment then it will eventually just allow the authorities to fund and bail out as in the cases of Greece etc. and as above, the more that the likes of France and Germany are committed then eventually the more pressure on their own ratings and bond yields. Still, it might alleviate the pressure in the short term and that has been the approach from the EU all along in this crises and the reality of the situation is that they have to stop the ever rising Italian and Spanish bond yields or its game over.

RBS reckons the ECB will have to buy on average around €2.5bn of bonds a day — equivalent to an annualised rate of €600bn — consistently.

Any signal that the ECB is only intervening on an interim period – that is until the EFSF is up and running – will give the market a sentiment that there is a finite limit on purchases (that of the EFSF buying power). In this context, uncertainties about the ECB’s ability to defend spread levels at any cost will be challenged. The discussion around the upscaling of the EFSF around the end of the year could be the time when spreads reach new wides.

And that’s the real problem.

ECB bond buying is temporary solution. A more permanent solution lies with up-scaling the EFSF so it has the fire-power to deal with Spain and Italy. However, that will threaten the rating of the guarantors – France and Germany – and could be unacceptable to their electorates.

This crisis ain’t over. Not by a long shot.

At pixel time, the 10-year spread on France/Germany was 74bps.

And here, via The Baseline Scenario, is a handy list of AAA sovereigns and their 10-year yields.

* Switzerland: 1.17
* Singapore: 1.79
* Germany: 2.34
* Sweden: 2.34
* United States: 2.56
* Denmark: 2.58
* Canada: 2.63
* Norway: 2.63
* United Kingdom: 2.68
* Netherlands: 2.77
* Finland: 2.90
* Austria: 2.97
* France: 3.14
* New Zealand: 4.50
* Australia: 4.64

Related links:
Le plan, negatifs taux d’intérêt – redux – FT Alphaville
Eventually, French Spreads Fail (E.S.F.S.) – FT Alphaville