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Vive La Republique!

Who’s next?

That was question everyone was asking after S&P stripped the USA of its triple AAA over the weekend. The conclusion seemed to be France.

But fast forward couple of days and a more considered view is emerging.

Sanford Bernstein:

S&P has declared that France’s AAA rating is stable. That is completely in line with the reasons for the downgrade of the US, which was more about concerns over the willingness of the US to pay than the ability of the US to honor its obligations. There is no indication whatsoever that France would waver in its determination to honor its obligations. In fact on July 21st, they signed along with the other European nations an undertaking to “honor their sovereign signature”. That is not to say that France would not need some structural reform to rebalance its budget, but that in itself does not warrant an immediate downgrade.

Indeed, President Sarkozy took the almost unprecedented step of recalling key ministers from their vacation (in August. Everyone in France goes away in August) to devise new measures to cut France’s budget deficit.

Gary Jenkins, Evolution Securities.

S&P is not going to downgrade France any time soon. Nor are Moody’s or Fitch. There has been a lot of speculation regarding an imminent downgrade of France by S&P.

However this is what the agency actually wrote when they cut the US AAA rating; “When comparing the US to sovereigns with AAA long term ratings…..the trajectory of the US’s net public debt is diverging from the others……in contrast with the US, we project that the net public debt burdens of these other (AAA rated, including France) sovereigns will begin to decline, either before or by 2015”.

This statement gives France some time. Growth will be the key to the stability of the ratings for France, UK and the US over the next 12 months. As we have said before significant slippage from agency expectations could well put pressure on the ratings of all three by this time next year and no doubt there will be a lot of attention on the French GDP numbers out this Friday. France faces one extra challenge to the others which is a possible build-up of contingent liabilities in order to assist other EU sovereigns.

Ah yes, an up-scaled EFSF. Surely that will imperil the French AAA rating.

No, says Nomura:

A key investor concern is that the French sovereign rating does not reflect contingent liabilities for the EFSF, which is a key stumbling block to increasing the fund’s size. The fund needs to be larger to credibly stand behind Spain and Italy, yet it must be backed by AAA sovereigns in order to retain its own AAA status.

Our rates team’s Rates Weekly of 5 August 2011 discussed what an increase in size of the EFSF would do to the debt/GDP burden of a AAA rated country, concluding that to double the size of the EFSF to cover the liabilities of the GIIPS countries out to end-2014 would add around 3% to debt/GDP, not in itself enough to imperil a AAA rating.


But Nomura’s argument rests on the EFSF only being doubled in size. There are many economists, among them Citigroup’s Willem Buiter, who think the rescue fund needs to have EUR2trn of lending capacity because of the systemic nature of the European debt crisis.

In that scenario France’s AAA rating would be imperilled. For that matter so would Germany as this recent note from RBS spells out.

Our simulation of the upsizing of the EFSF to an effective lending capacity of Eur2 trillion would require Eur3.45 trillion of guarantees. This is because the maximum lending capacity is constrained by the total maximum guarantee commitments of the AAA countries.

In a worst case scenario where all lending capacity is considered as debt then this would cost Germany an extra Eur727bn or 28% of GDP on top of its existing (Eur212bn worth of) guarantees. This would bring the German debt above 110% of GDP. The increase in the maximum French guarantee commitment would increase their maximum contingent liability from Eur159bn to Eur705bn, equivalent to an increase of 27% of GDP, and would take the debt/GDP ratio higher to 112%.

(Remember France contributes 20 per cent of the EFSF guarantees, or up to 35 per cent if only the AAA-rated countries contribute).

Now the above is, of course, very much a worst case scenario. Unfortunately, after four years of near constant crisis, investors are very much prepared to think the worst.

Roll on Friday and those GDP figures.

Update: 09.55am (London time).
Interesting observation from RBS banks team:

We see the debate about a potential rating downgrade of France as a secondary cause. Moody’s and S&P both confirmed that they have no plans to downgrade. More importantly, France is already trading 90bp wider than German bunds, implying a market view well below AAA. And in the cash market, French and German bonds traded in synch yesterday (16 and 17bp tighter, respectively), displaying no incremental anxiety about sovereign rating fears about France. We would be cautious to attribute too much to sovereign CDS moves. We understand CDS have become a lot less popular after ISDA’s decision that the Greek restructuring would not trigger CDS payouts.

Update: 10.58am (London time)
JP Morgan preview of Friday’s GDP release.

With France in the focus of markets, tomorrow’s GDP report will attract significant attention. At the beginning of this week, we had pencilled in an increase of 0.1%q/q (not annualised), while the Bloomberg consensus was for an increase of 0.3%q/q (not annualised). If we incorporate yesterday’s weak IP report for June, we would revise this down to to flat. Our tracking tool, which uses IP, goods consumption, construction output and the services PMI, even points to the possibility of a marginal decline, given that the standard error around the central estimate has been +/- 0.2%-pts (not annualised).

We would note that a number of temporary factors will weigh on the result and that we would average 2Q11 with the strong first quarter. In particular, the car scrappage incentive, which expired in December, was still boosting spending during 1Q11 (due to late deliveries). The payback was hence delayed until 2Q11, with consumption of goods down 7%q/q saar largely due to a 37%q/q saar plunge in spending on cars. This weighed on IP as well, which fell 2%q/q saar in 2Q, while in construction there was payback after a weather-related rebound in 1Q11. That our tool is not predicting a big contraction is mostly due to the surveys. The French composite PMI averaged a strong 59pts in 2Q, with the services PMI just over 60. Hence, the underlying pace of growth was still solid in 2Q11.

The business surveys did weaken significantly as we went through 2Q11. And the weaker global backdrop and recent movements in financial markets will act as significant headwinds. Nevertheless, if we were to stop the clock in July, the French composite PMI was still in expansionary territory (at 53.2).

Related link:
France will feel the impact of USAA+ – FT Alphaville