Two days ago we highlighted Moody's full report on sovereign AAA ratings, in which the rater was highlighting its own impotence of knowing full well that both the US and UK are unworthy of AAA ratings, yet unable to do anything about this, as a downgrade of either would set of a chain of events that could potentially undo the last year of house of card building by both key governments, who have set off on creating the biggest ponzi scheme in the history of the world, and whose collapse would result in the same social unrest that was expected to happen in the UK if RBS and HBOS were to fail (which presumably was averted by literally last minute action). Today, none other than glass house inhabitant Citigroup, which would not be in existence if the true state of financial and economic affairs was disclosed in even one tenth of its magnitude, bashes Moody's as being, gasp, too optimistic. Citi analyst Mark Schoefield says "in our view the pre-budget report leaves us significantly closer to a negative ratings action by virtue of having done nothing to slow the current pace of deterioration in the fiscal position."
Some of the key observations from Citi:
The UK has certainly not been immune to the moves elsewhere with the 5yr CDS widening to 85bp from 45bp two months ago, while 10yr swap spreads have come in 30bp over the quarter. We think this is understandable given the UK's grim fiscal outlook and certainly should raise the question as to whether or not the UK's AAA rating is sustainable against a fiscal position that really belies that status. Our economics team continues to stress that the deficit is likely to remain elevated for many years and that debt is heading steadily towards 100% of GDP.
Crucial to the UK maintaining its status are assumptions that the economy has begun to expand sustainably. Absent this assumption, the expected fall in longterm revenues has not been offset, as yet, by any commensurate reduction in expenditure and as such the European Commission sees the structural public deficit in excess of 10% of GDP. This, Moody's describes as "an inexorable deterioration of debt affordability in the short-term under almost all foreseeable scenarios".
Given the importance that Moody's attaches to debt affordability, the key phrase appears to be "in the short-term". Moody's seems to be giving the UK the benefit of the doubt on the back of a perception that debt affordability and reversibility are high and more than likely because it feels that the outcome of the general election is too close to call and therefore the fiscal path down which the UK will go in 2010 is as yet unclear.
Looking at the Moody's report in a little more detail, it cites among other factors, the ability to issue inflation-linked Gilts at close to zero real yields and strong demand for Gilts, albeit boosted by the asset purchase facility, as key factors that make the UK resilient rather than vulnerable at the current point in time. The other key factor supporting the UK's rating is a belief that the public consensus will now permit any of the main political parties to follow through their pre-election pledges for fiscal restraint, whatever the outcome of the election.
It is on these points that we think Moody's current assessment is too generous, or at least that the consensus perception of what Moody's is saying is too complacent. We think debt affordability and reversibility look set to deteriorate rapidly and in very short order for three reasons. Indeed, it may be the case that Moody's sees this too but that in the near term is prepared to offer a little slack while the political situation is resolved and to allow the incoming administration a short while to put a credible fiscal plan on the table. We doubt, however, that this patience will hold for very long given the rapidly deteriorating outlook and the lack of evidence of a credible solution.
We understand Moody's assessment of the short-term outlook, but we see significant risk of a marked and rapid deterioration in both debt affordability and reversibility that could quickly become self reinforcing. Unless we get a credible set of measures put in place quickly, which seems unlikely unless we get a Conservative government with a clear majority at the next election, we think the UK's Aaa rating will be right up on the radar screens in a very short space of time. The lasting legacy of the current administration may well prove to be the loss of the UK's AAA credit rating.