Just in case you were wondering.
Bond markets still react to sovereign ratings announcements, though they tend to react more when the rating agencies say something negative. That’s the conclusion of a new working paper from the European Central Bank, which looked at changes in yields and CDS spreads after rating actions from Standard & Poor’s, Moody’s and Fitch on two dozen European Union countries from 1995 on.
The ratings data itself is rather interesting. Since 1995, there were 394 rating announcements from the three rating agencies. S&P and Fitch were the most active, with 150 and 138 announcements, whereas Moody’s had just 108. Out of these announcements, most of them were upgrades (167) and positive outlook announcements (88) rather than downgrades and negative outlooks (79 and 60, respectively).
But boy, how life has changed.
Here’s the conclusion from authors António Afonso, Davide Furceri and Pedro Gomes:
Our main results can be summarised as follows: i) we find a significant response of government rating bond yield spreads to changes in both the credit rating notations and in the outlook (with some differences across rating agency); ii) the response results are particularly important for the case of negative announcements, while the reaction of spreads to positive rating events is more mitigated; iii) sovereign yield spreads respond negatively (and weakly) to positive events in the EMU countries, but not in the non-EMU country sub-sample, while the response to negative events is this case is quantitatively similar across country-sub-sample; iv) the reaction of CDS spreads to negative rating events has increased after the 15th of September 2008 Lehman Brothers bankruptcy; v) rating and outlook announcements are essentially not anticipated in the previous 1 or 2 months but; vi) there is evidence of bi-directional causality between sovereign ratings and spreads in a 1-2 week window; vii) we find evidence of rating announcement spillover effects, particularly from lower rated countries to higher rated countries; viii) finally, countries that have been downgraded less than 6 months ago face higher spreads than countries with the same rating but that have not been downgraded within the last six months implying a persistence effect.
The abovementioned conclusions shed some additional light on the behaviour of capital markets vis-à-vis sovereign credit rating developments. The fact that negative rating events take markets mostly by surprise, can either imply that fundamentals are not fully discounted on a more permanent basis by markets participants or that rating events have, to some extent, gone astray of such underpinnings in some events. On the other hand, our analysis also shows that the reaction of EU spreads to credit rating events is clear and quick (within one to two days), which implies that good macroeconomic fundamentals and sound fiscal positions are key to prevent, first, rating downgrades, and then, the upward movement in yields and spreads.
Sounds like fuel for the ECB’s-own-rating-agency-fire.
Oh, and if you’re wondering about the suggestion of differences between agencies in point i) …
When it comes to bond yields, spreads react “significantly” only to negative S&P announcements (and “marginally” to positive announcements from Moody’s). Meanwhile, CDS spreads increase after negative Moody’s and Fitch announcements, and decrease when positive S&P announcements occur.
Related links:
ECB must re-examine its dependence on rating agencies - Erik Nielsen, Goldman
Machine-readable sovereign downgrades are here - FT Alphaville
When sovereign ratings turn on a dime - FT Alphaville
Losing my (AAA) religion - FT Alphaville