On Friday the S & P downgraded nine Euro zone countries including AAA rated France in a move that highlights some of the future economic and credit risks that await Europe while many Euro zone countries enter a new period of austerity and recession.
Among the downgraded countries are France, Austria, Malta, Slovakia, and Slovenia which were all lowered by one credit notch. France loses its coveted AAA rating, moving down to AA+.
Portugal, Spain, Italy, and Cyprus were downgraded by two notches. Italy’s credit rating fell to BBB+ which is close to junk bond status and makes it more likely for continued pressure with their bond yields.
Today’s credit downgrade of nine Euro zone countries comes in response to the outcome of the December 9th European Summit which failed to assure the S & P credit agency that the right choices are being made by European policy makers to handle Europe’s sovereign debt problems in a clear and sustainable fashion.
“In our view, the policy initiatives taken by European policy makers in recent weeks may be insufficient to fully address ongoing systemic stresses in the Euro zone,” the S & P wrote in a statement.
The S & P explained that the Euro zone faces increased stresses, including tightening credit conditions and external environmental headwinds that make future growth difficult across the Euro zone.
John Makin, a former consultant to the IMF and Treasury Department and resident scholar at American Enterprise Institute, told Bloomberg’s Mark Crumpton that France’s downgrade was not a surprise and not good news.
Makin agreed that a domino effect may impact other countries in Europe which translates into higher borrowing costs.
When asked what the downgrade will do to the potency of Europe’s rescue fund, Makin admitted that it weakens the overall potency of the rescue fund and places more pressure on Germany to underwrite Europe’s rescue fund, the EFSF.
“Six ago months France and Germany were in the core of good credit in the European Monetary System, now we are down to Germany only.”
As a result of today’s downgrade for Austria and France, the Euro rescue fund, which has no real credit worthiness of its own and relies on the good credit ratings of countries like France, Germany, and Austria to finance their bailout fund, the latest downgrade causes more financial stress for the long term firepower of Europe’s rescue fund to bail out debt burdened countries within the Euro zone such as Greece.
The reduced credit rating for Austria and France lowers the overall financial firepower and financial guarantees of the rescue fund from 451 billion to 271 billion, or 180 billion euros.
Greece will need 14.5 billion euros in March to repay maturing bonds in addition to billions more that will be due in the future.
Today’s credit downgrade will also increase the borrowing costs for France and the other downgraded countries, making it more difficult to sell long term paper. On January 16th France will sell 8.7 billion euros of debt in the bond market. In 2012 1.3 trillion euros worth of bonds will need to be refinanced for several different countries in the Euro zone.
Although the S & P’s downgrade causes financial stress within the Euro zone, today’s credit downgrade was not unexpected. The stock markets have more or less priced in an S & P downgrade, knowing that it was likely to occur in the near future.
After the news leaked in the morning hours about the looming credit downgrade, the U.S. equity markets dropped below 1.0 % across all major indexes before moving higher in the afternoon to close lower by only a modest level. The Dow closed down -48.96 or -.39%. The NASDAQ was down – 14.03 or .51%. The S & P 500 closed lower by – 6.41 to -49%.
The U.S. stock market closed marginally higher for the week. The Dow was up .5%. The S & P 500 was up .9% and the NASDAQ closed up 1.4%.
Next week will be a shortened trading week for the U.S. market since the market is closed on Monday in observance of Martin Luther King Jr. Holiday. Debate is already emerging between the equity bulls and market bears about the direction that the U.S. markets will take in the days ahead.
The equity bulls believe that the market should be moving higher, pointing out that the U.S. equity markets have displayed amazing resiliency in recent trading days, climbing back to their 6 month highs from July. They also point to a decoupling of the S & P and the declining Euro which moved in tandem near the end of 2011 during the heights of the Euro zone crisis.
The bulls point to improving U.S. market data related to the U.S. unemployment level, U.S. consumer spending, manufacturing, consumer confidence, and housing starts to make the case that the market should continue to climb higher in the weeks ahead.
Market bears counter that the recent improvement with the U.S. unemployment level was only temorary due to seasonal hiring during the holidays. The spike in jobless claims released this week in the market further bolsters their claim that the impressive December jobs report does not conclusively mean that the U.S economy is out of the woods just yet.
The final vedict won’t be decided until weeks ahead after the January jobs report is released.
Market bears also highlight the weak macro environment that lingers in the global economy and the overall U.S. housing market.
Uncertainty in the Euro Zone will impact future guidance for U.S. companies and make quarterly forecasting challenging. Quarterly earnings season has already kicked off this week and will continue next week.
The greatest exposure to Europe’s credit and debt problems lies in the U.S. credit markets and financial institutions, which have close alliances with Europe’s stressed out financial sector.
Since growth in China appears to be weakening relatively speaking compared to their growth rates in 2010 and 2011 and speculation persists about the extent of China’s landing with their real estate bubble, there is increased pressure for the United States to be a strong growth engine for Europe and the global economy.
It remains to be seen whether the batch of U.S. economic released in the months ahead will be strong enough to move stock indexes higher, especially in the midst of a barely recovering U.S. housing market, fiscal austerity across state governments, and a still fragile U.S. unemployment environment.
In an election year, when the health of the U.S. economy will be closely examined and dissected, there will increased pressure for the U.S. economy to outperform and drive international growth higher for an increasingly worried global economy.