Last Wednesday we put up the following blurb: "Five months ago, when Italian yields were still tame in the 3% ballpark, and not 7% where they are today, we suggested that based on trading patterns and overall volume in Goldman's dark pool, Italy may be about to experience a "Greek episode." Days later we were proven right as Italian yields and spreads started their relentless move wider, with only those who had access to Sigma X being able to get an advance whiff of what was about to happen. Well today we are happy to report that the German diversion may have worked: the truth is that nobody appears to care about Germany. Instead what everyone does seem to care about, is the nation with the greatest combined debt (government, corporate and household) to GDP in the world. Yup. The UK." Following that, a quick Twitter update from this morning indicated something was again going on with the UK from the perspective of the world's most connected insiders: "UK's LLOYDS and RBS top of most active on Sigma X this morning." Sure enough, here's Fitch with what may well be a precursor to the bond vigilantes finally focusing their attention on the last, latest and greatest AAA credit.
- FITCH: UK GOVT MAY BE MOST INDEBTED OF AAA SOVEREIGNS EX U.S. -BBG
- FITCH: NEW UK FISCAL VIEWS 'SIGNIFICANT DETERIORATION' VS MARCH - BBG
- And the punchline: "the capacity of UK public finances to absorb adverse economic and financial shocks that would result in yet higher public debt while retaining its 'AAA' status has largely been exhausted"
And cue the imminent downgrade rumors.
For those who enjoy visual cues, here is today's Sigma X update:
And the full Fitch statement:
FITCH COMMENTS ON UK AUTUMN STATEMENT
Fitch Ratings-London-29 November 2011: Fitch Ratings says the Autumn Statement and the updated fiscal and economic projections from the Office of Budget Responsibility (OBR) confirm the scale of the budgetary challenge facing the United Kingdom ('AAA'/Stable Outlook). The revised fiscal projections signal a significant deterioration relative to the March 2011 assessment by the OBR.
The sharp downward revisions to the OBR's assessment of the near-term outlook has brought them in line with consensus and Fitch's own forecasts of growth of just 0.7% in 2012 before rising to 2.1% in 2013. However, the OBR has effectively lowered its estimate of the size of the UK economy by the end of the period 2015-16 by around 3.5 percentage points. Consequently, the UK government's goal of eliminating the underlying structural budget deficit is now projected by the OBR to be met in 2016-17, in line with the government's rolling mandate, rather than its previous estimate of 2014-15.
The UK government has responded to the deterioration in the economic and fiscal outlook with additional measures with reductions to current spending amounting to GBP15bn by 2016-17 which over the remainder of the current parliament is used to fund temporarily higher capital spending. Subsequently, the savings on current spending feed through to a significant fiscal tightening in the first years of the following parliament.
Fitch's initial assessment is that the policy response does demonstrate a continuing commitment to placing UK public finances on a sustainable path, and the adoption of more realistic economic forecasts enhances the credibility of the consolidation effort, while the important target of reducing the public debt burden from 2015-2016 remains intact. However, the deterioration in the economic and fiscal outlook implies that net public sector debt will peak at 78% of GDP compared to the previous OBR forecast of 70% in 2014-15. On a broader measure of government debt used by Fitch in international comparisons, the UK government will become the most indebted of any 'AAA'-rated sovereign with the exception of the US ('AAA'/Negative Outlook). UK government debt is on this measure projected by the OBR to peak at 94% of GDP and compares with Fitch projections for Germany and France of 83% and 92% respectively.
As with some other major 'AAA'-rated sovereigns, unless off-setting measures were adopted, the capacity of UK public finances to absorb adverse economic and financial shocks that would result in yet higher public debt while retaining its 'AAA' status has largely been exhausted.
All of which is massively ironic given the vastness of safe haven flows into Gilts the last few weeks. The spread between Bunds and Gilts is at its tightest (Gilts < Bunds now) since 2000 (upper pane in the chart above). The differential (lower pane) has seen the largest two-month move since 1992! So now where does that safe-haven-seeking money flow? US TSYs are bid post Fitch's statement!