UBS Explains Why AAA-Loss Is Actually Relevant

Tyler Durden's picture

As the buy-the-ratings-downgrade-news surge on European sovereigns stalls (following a few weeks of sell-the-rumor on France for example), the ever-ready-to-comment mainstream media remains convinced that the impact is priced in and that ratings agencies are increasingly irrelevant. UBS disagrees. In a note today from their global macro team, they recognize that while the downgrades were hardly a surprise to anyone (with size of downgrade the only real unknown), the effect on 'AAA-only' constrained portfolios is important (no matter how hard politicians try to change the rules) but of more concern is the political impact as the divergence between France's rating (and outlook) and Germany (and UK perhaps) highlights harsh economic realities and increases (as EFSF spreads widen further) the bargaining power of Germany in the economic councils of Europe. Furthermore, the potential for closer relationships with the UK (still AAA-rated) increase as the number of AAA EU nations within the Euro only just trumps the number outside of the single currency.


Chart: Bloomberg

UBS Global Macro: La politique lorsqu'on n'est plus AAA

The news that credit rating agency Standard and Poor’s were downgrading economies across the Euro area was hardly a surprise to financial markets. The number of notches of each of the moves and precisely which countries were to be involved were really the only elements of surprise left to investors. The reaction has tended to focus on the downgrade of France from AAA status. This was perhaps inevitable. Credit rating agencies do not generally command the respect of the markets. However, the loss of AAA status is still something that matters at a time when a number of portfolios are still constrained to “AAA only” holdings.


It is not the threat of default that concerns France’s loss of AAA status is hardly likely to raise concerns about creditworthiness in definite terms. The popular media have tended to explain the consequences of the downgrade as “France’s borrowing costs will rise”, but even that is not certain in absolute terms (and in relative terms France has already seen its spread to Germany widen). The integrity of the French government’s credit is not really in question. Indeed, the British financiers the Rothschilds profited handsomely in the nineteenth century by observing that, since the revolution of 1789, French governments would honour the debts of their predecessor regimes. The cycle of republics, monarchies and empires did not threaten the credit of the French state. In France, the state transcends the market’s perception of credit risk.


This does not mean that markets can afford to ignore the downgrade of France. For once, economics is not perhaps the most important facet of this decision. This may be one of those rare occasions where politics is more important than economics.

The politics of relative decline

France has not only lost its AAA status. Critically, France has lost AAA status at a time when Germany has not. France also retains a negative outlook against a stable outlook for Germany, compounding the distinction. The relative decline of France’s credit rating is something that has potential political implications. There are parallels here to the relative positions of the UK and the US in 1949, in the wake of sterling’s devaluation against the dollar. The devaluation was simply a confirmation of economic reality, but the visible confirmation of that shift in relative economic reality served as a defining moment in the shift of the bilateral relationship in political terms.


Since the foundation of the Coal and Steel Community in 1951, the history of (continental) European politics has been essentially a story of France and Germany holding each other in check. Indeed, this was the explicit aim of the ECSC’s founders. With the downgrading of France relative to Germany, there is now a de jure as well as a de facto inequality between the two states. The ability of France to act as a counterbalance to Germany in economic decision-making has been compromised.


In the wake of the downgrade of the EFSF, it is clear that the actions of S&P have elevated the role of Germany (and perhaps, to a lesser degree, the Netherlands) in any collective economic decisions within the Euro area. Any economic decision that requires money to be spent will require wholehearted German endorsement if rating agency determined credit credibility is to be maintained. The bargaining power of Germany in the economic councils of Europe has been correspondingly increased.

So what?

So what does this mean? The consequences are not that clear. There may be disquiet from several Euro area countries (and not just those of the periphery) at the idea of a more dominant Germany. This was not the vision of Europe motivated the foundation of the EU.


France could choose to tie itself closer to Germany – to co-opt Germany’s presumed credit (or possibly economic) superiority, in effect. This was generally the course that the British took towards the Americans in the post-war era – the Suez and Vietnam conflicts being aberrations. There is also a Franco-German precedent for such a “borrowed clothes” approach in the French attempts to wear Germany’s monetary credibility during the “franc fort” regime of the 1990s.


Such an alliance would generate a very Teutonic accent to the Euro area. To some extent we have that already – the bias has been to a more German-centred approach to resolving the series of crises that have plagued the Euro area.


However, a France that seeks to bind itself more closely to Germany would presumably mean that the current bias becomes an established trend. The risk here is that a tighter Franco-German alliance under more explicit German leadership would alienate peripheral countries within the EU, and lead to more acute EU policy sclerosis or overt policy discord.


The alternative is that the Euro area pursues a more holistic approach to negotiation. Rather than having decision-making driven by France and Germany (deciding the main conclusions with a bilateral meeting ahead of each emergency summit), there is the possibility of a more shifting coalition of interests shaping the outcome of the assorted emergency summits. Euro area countries would look to achieve a broader coalition to defend their interests, rather than rally to the French standard or the German standard as appropriate.


In extremis, it is possible to imagine that the Euro area will seek to end its isolation from the United Kingdom, and instead solicit UK help as a possible (AAA-rated) foil to German policy initiatives. The involvement may be a step too far, however (from the perspective of the UK as much as of the Euro area). To the extent that a broader coalition including non-Euro countries is brought in to play, it could be construed as more market-friendly: the non-Euro countries tend to be more inclined to favour the markets. This could also be seen as a more pro-market, competitive measure. Before dismissing the idea of non-Euro alliances being sought, it is worth reflecting that there are now almost as many AAA EU countries outside of the Euro 17 as within the single currency.

Politics means this matters

The downgrading of France from AAA was not, of itself, a major surprise. France has not traded as a AAA economy for many months now. This does not mean that investors should dismiss the downgrade as irrelevant. Rather, we should perhaps view this as a 1949 moment. A key bilateral relationship may be redefined by the visible confirmation of what is already an economic reality. How this political situation resolves is of great economic import.

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Mongo's picture

Zero Hedge is about the only thing on the Internet that is AAA-rated

SimpleandConfused's picture

Great site, no doubt.

But the market sure isn't buying the doom scenarios.  I'm guessing DOW 15K before DOW10K?  Maybe in the next couple of months?  For whatever reason (bad news = fed printing = market up / good news = economy improving = market up?) the thing just won't slow down.

No idea if we will ever have a nation of workers again.  Maybe everyone on SNAP and receiving UE benefits?  Seems to work in the greater ATL metro area.

Mr Lennon Hendrix's picture

The balance sheets of the Fed and ECB are each $3 trillion.  Fiat is losing perpetual value.  All prices move up accordingly.

The Axe's picture

it may be moving it....look at any excuse I guess...but bonds are weak and the disconnect between Nat Gas and WTI will bring pain someday....also C is a big deal, but the market may never

blindfaith's picture

the smell of very old conflicts is in the air.  If France thinks the UK will suddenly get in bed, the French don't understand that the UK has a memory too.  The politics of nationalism is rising from the debt ashes.

Mr Lennon Hendrix's picture

Golden Cross coming up bitchez!  Mother fuckin' Golden Cross!!  Time to buy!  It's all priced in!

adr's picture

I like the news story showing consumers actually paid down credit card debt by 11% last year. There was no increase in credit card debt. However auto loans increased dramaticaly, the most in Alabama to an average of $20k. THE STATE WITH NEARLY HALF ITS POULATION ON SNAP!!! It just so happens that $20k is the average transaction cost of a new Chevy Cruze. Ha,ha, ha  sub prime $20k car loans to SNAP beneficiaries. BULLISH ALL THE WAY MAN.

Cadavre's picture

Are not FCUs, state, federal, municipal and school district "fund" treasurers "constrained" to AAA paper?

If that is the case, where are they getting their bonds from?

blindfaith's picture

Indeed. Three cheers for Tyler and his staff and contributors, Diogenis would be proud.

 But..Of course, the rating agencies were important when they whored their 'services' out to the banks to steal the retirements, lives and homes of individual human beings around the world by selling AAA rated worthless paper.

WhiteNight123129's picture

To which extent is the price structure distorted? If you get data from Tooke, Jevons, Marshall from XIX and first half of XX century, the result is that Gold is at a very high level against wheat.

Has anyone pondered the impact of conflict in IRAN on soft commodities? In that case, the sector which is the anti-paper and needed continuous subsidy (agriculture) would not need it anymore. Sugar does not need it anymore in Europe. Now which country in Europe has very fertile land and can generate forex out of it??IT is not Germany.

Paper mania of 1999 made all farmers poor. USA also has a strong agriculture which can generate Forex (yes I know people here will say that USD is reserve currency, but for how long?). Call me crazy, but ponder the price structure distortion.


GerritB's picture

In other news: Dutch FM says no extra funding for EFSF will be available.

Good, don't want to see my tax money trown down the drain....

Everybodys All American's picture

---> Blowoff top

---> Breakout

Mr Lennon Hendrix's picture

The market will remain volatile for another three weeks while the Central Banks loan the freshly printed, hot and wet cash they have to Private Banking Houses to buy debt issuance who then flip the debt back to the CBs only to increase their holdings of stock and such.

We are now waiting for the next round of money printing, which as the half life continues to degenerate, should only be a few weeks, when the Fed steps in on the next downdraft and issues QE X.

Cadavre's picture

Judging by the indexes, sinking ships float indexes.

The FED's flash MBS monetization has "surged" the primaries to unfathomable fraudulent highs this morning. Yaz gotz ta hand it to the Berskank and his directors: there is no low they would be unwilling to stoop too to devalue the USD to keep pace with the bottom dropping out from under EZ fiat tokens.

And this time they be wearing a little bo peep outfit - patent leather shoes evun.

It almost seems the EZ indexes got the telegraph from the FED before they opened.

How do you spell "last hurrah"?

Got to blackout my web site - later.

Cult_of_Reason's picture

Buba Distances Itself From Board Member's Criticism of ECB Bond Buys

FRANKFURT (Dow Jones) -- The Deutsche Bundesbank ("Hard Money" Hypocrite) Tuesday distanced itself from criticism that a member of its executive board (Thiele) launched Monday night against the European Central Banks’ program of buying euro-zone government bonds.

blindfaith's picture

EVERYONE is so used to grading on a curve that no one sees the bottom until they turn around and look behind them.  Of course, since we don't teach history or civics anymore( I mean true history, not the twisting con-cock-sion in modern text books) who would know anyway.

As long as all the banks and countries are bankrupt, it doesn't really seem that anyone stands out.  Bankrupt is the new solvent.  And, debt is the new status symbol of indifference.

Gubbmint Cheese's picture

Money pouring out of Europe and into US safe haven stocks and UST's.. Nothing more.

LawsofPhysics's picture

Paper pushing fucknuts explaining why paper ratings are relevant.  Right.....



EconSammie's picture

One area where the downgrades did have an influence was on Portugal where he government bonds fell heavily yesterday. Also her economy is facing a severe contraction as the article linked to below highlights.

The latest evidence

Let me pass you over to the Portuguese INE

Services turnover index intensifies negative trend

In November, the year-on-year change rate of services turnover index, adjusted for calendar and seasonal effects, was -11.7% (-8.9% in the previous month). Comparing with November 2010, employment, wages and salaries and hours worked, adjusted for calendar effects, decreased by 4.9%, 3.0% and 4.7%, respectively. By the same order, the yearon- year change rates in October were -4.2%, -4.0% and -3.9%.

So we have the largest part of the economy not only declining but doing so at an accelerating rate. So a year on year reduction of 11.7% is severe and raises the risk of by-passing recession and going straight to a depression.

Oh well never mind maybe construction can help out.

The index of production in construction decreased by 11.6% in the quarter ending in November 2011, in year-on-year terms (3 months moving average, working days and seasonally adjusted), down by 1.4 percentage points from the rate observed in October. Employment and wages and salaries registered year-on-year change rates of -11.9% and -9.3%, respectively.

BandGap's picture

The real relevance is what direction France moves at this point.  If the country aligns with Germany then you can bet there will be many in the EU that will begin shuffling away.  The chasm will form immediately based on the perceptions of the Portugese and Spaniards (the Greeks have little significance at this point). The fractures could lead to a complete unwinding of the EU.

Never in my lifetime did I think I would witness what I am seeing these past few months.


847328_3527's picture

odd how they pumped selling these bonds when they AAA rated...suddenly ratings don't matter....


Best to ignore news that does not fit with your views, eh.

Dr. Gonzo's picture

I guess destroying money and making sovereign debt so risky is one way to juice the stockmarket.

orangedrinkandchips's picture

Obviously the rating agencies are WORTHLESS...however, most "institutions" have to abide by their calls however relevant. FINALLY the agencies are doing what they should and calling these people out...I mean it's the epitome of "too little too late"....but seriously, it's either do your job in an unbiased, unbribe'd way or get out.


Wait, let's pay a fortune for bullshit.....that is basically it. Pay these agencies to just blow shit up your ass.....


Now or never....credibility is gone...must get something back....i guess.


Fitch= wortheless as teets on a boar.....


And like my son's friend says about the Greek default before the 20th of March..."NO DUH!"....You dont need a weatherman to know which way the wind blows for christs sake!


Greek default on 18Billion? NO SHIT SHERLOCK.

mirac's picture

How in the world does Britain maintain an AAA rating.  Did they find a way of exporting "bubbles and squeak"?

Mr Lennon Hendrix's picture

Londontown has been the financial centre of the globe for centuries, it isn't about to be the first in the pool of sharks.  They will get down graded next month, and this will be an epic event.

mirac's picture

And if my memory is correct, hasn't Britain failed to pay their debts will currency debasement twice in the last century?

slewie the pi-rat's picture

in related news, S&P's rating for itself has been dropped 6 notches to BBBiCheZ!

The politics of relative decline = fringe blogging [where every friendly smile and happy word gets an immediate knuckle sammy]


Mr Lennon Hendrix's picture

I agree with that, however, (and not that you have) for anyone to say that the States should not be downgraded is ignorant.  Are the corporations trying to destroy Nation-States?  Yes.  But the States are over ridden with debt, plain and simple.

What should be done is to downgrade everything and start from scratch.  That would be fun.

swissaustrian's picture

Wake me up when somebody downgrades the UK, the real heart of the beast called "global banking system".

Overflow-admin's picture

Oh yeah thanks for the reminder... less and less AAA denominated assets will logically lead - as we consider the system is heavily rigged - to a greater flow into the remaining AAA denominated assets. This is really not good because it will only lead to more bubbles and crunchs.


So bad the system has no backup, if we could restore it to a previous state it would be easier to handle...

CFDBroker's picture

oh mores oh times

koperniuk666's picture

what if Germany and Uk were to get together and form a New Euro currency?

why not?

RiverRoad's picture

Politics rules these days.  Economic fundamentals have gone out the window.

Ghordius's picture


what incredible drivel is again spouting from those UBS whizkids. what an utterly idiotic angle, complete with the usual EU/EZ exchanges since they seem to think the majority of their UK and US based customers is anyway too ignorant to understand the difference between European Union and EuroZone and a totally whacky view on european history. honestly, I don't even know where to start...

you can unlearn more about the relationship between Germany, France and the UK by reading this paper than learn by living in them for decades. seriously, they have found anti-learning. yeach!