One of the more impressive moves in recent months among the universe of European bonds, has undoubtedly been that by French OATs, which have actually outperformed Bunds in recent years, with the OAT-Bund spread the tightest it has ever been...
... even as the French economy has cratered in the past year under its socialist regime, and far from being one of the "core" European economies, is now increasingly considered B-grade at best.
Whether this miraculous performance, in which the market is doing the opposite of what the fundamentals suggest, is due to the ECB-intervention or simply because asset managers have stuck their collective head in the sand of willful ignorance is irrelevant, but according to Citi this latest period of complete disconnect between reality and market may be coming to an end as soon as the Friday when none other than Moody's may put France, and its Aa1 rating, once again on review for a downgrade.
From Citi's Peter Goves:
Downgrade risks have increased for France this week
France has been rated Aa1 with a negative outlook by Moody’s since November 2012. France appears increasingly isolated with its negative outlook given that Moody’s has upgraded several sovereigns this year, revised various outlooks back to stable (Figure 1) and notably, did not revise the outlook back to stable when France last appeared in its calendar on 23rd May. France next appears on Moody’s calendar this Friday (19th Sept). In their latest Credit Opinion (5th August), Moody’s indicated that they would likely downgrade France’s rating if:
- Moody’s confidence in the likelihood of the implementation of the proposed reforms or their effectiveness were to decline,
- Moody’s views on the country's medium- to long-term growth prospects were to deteriorate further,
- Moody’s expectation with respect to the medium-term path of the general government's debt/GDP ratio were to drift towards 100%.
Why we think downgrade risks have increased: Over the course of the last year, economic performance has been disappointing, with zero QoQ GDP growth both in Q1 and Q2. In light of this, Moody’s stated on 18th August that they have “cut 2014 real GDP forecast to 0.5% from 0.6% and our 2015 growth forecast to 0.9% from 1.3%” signalling a further deterioration in their growth outlook. Furthermore, finance minister Sapin recently lowered growth forecasts (2014 to 0.5% from 1%) and raised deficit forecasts (now expecting 4.4% in 2014 and 4.3% in 2015, Figure 2).
Moody’s stated the fact that France will miss its 2014 deficit target was credit negative on 18th August.
Outlook therefore unlikely to be revised back to stable: We believe it is now less likely that Moody’s revises its outlook to stable on Friday. Instead, we believe it is more likely that Moody’s puts France formally on a “review for possible downgrade” with a conclusion probably coming after the budget (due on 1st October).
Of course, all of the above assumes that rating agencies are still relevant in a world where central-planning has made all non-central banker opinion irrelevant; furthermore with the ECB now openly buying up ABS, will even a one notch downgrade in France matter.
At the end of the day, even if Citi is right, it will be all about nationalist pride, one of the few things France has left. And judging by France's hysterical reaction to its first rating agency fall from grAAAce, anything Moody's does, as irrelevant as it may be, will be worth the price of subprime, CCC-rated, and securitized popcorn.