Citi Has First Reaction To Moody's Downgrade: Not Surprising But More EURUSD Downside

From Citi's Steven Englander:

Moody's downgrades France to Aa1 from Aaa -- negative outlook

Moody’s cited  deteriorating economic prospects, loss of competitiveness, structural issues and uncertain resilience to negative shocks. They also cite France’s funding costs (even though borrowing rates are close to record lows.)  On the negative outlook, Moody’s says “Moody's would downgrade France's government debt rating further in the event of additional material deterioration in the country's economic prospects or difficulties in implementing reform. Substantial economic and financial shocks stemming from the euro area debt crisis would also exert further downward pressure on France's rating.”  The comments are fairly general, as with the US downgrade last year. If anything the emphasis on the deteriorating growth picture may add some pressure for the ECB to ease but with france 2yr yields at 11bps, its growth prospects would probably benefit more from an easing of sovereign concerns in the peripherals than from a cut in ECB policy rates.

Moody’s alsdo reminds that “Moody's currently also holds negative outlooks on those Aaa-rated euro area sovereigns whose balance sheets are expected to bear the main financial burden of support via the operations of the EFSF, the ESM and the ECB. Apart from France, these countries comprise Germany, the Netherlands and Austria."  So the French downgrade may presage others to come

As with the US downgrade last year, little of what they cite is new and the downgrade reflects a reality that has probably long applied to France and applies to a number of the remaining Aaa countries as well. At today’s 90, France’s CDS was trading a little higher than  Poland and Estonia and a little below Qatar, Abu Dhabi and Belgium. The 10yr spread versus Germany is in the range of the last three months, and close to where it was in August 2011 before Spain became a major issue.

With EUR now at 1.2773 versus 1.2816 just before the announcement there is probably more downside till the kneejerk reaction is out of the way. But on the whole it seems likely that this more reflects an already existing reality than new information for the market so the downside should be relatively limited, and nothing that could not be cured by an aggressive Fed indication on balance sheet expansion.


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