July 24, 2012

Moody’s Cuts Outlook on Germany, Luxembourg, Netherlands

Outlooks dropped to negative as Spanish economy worsens

Germany, the Netherlands and Luxembourg saw their outlooks downgraded to negative by Moody’s Investors Service late Monday as debt woes in the eurozone continued to worsen. Spain drew the focus of much of the market’s worries, with yields soaring at a Tuesday debt auction.

Reuters reported Tuesday that Moody’s took the action against the three countries, citing a rising chance that Greece would be compelled to leave the joint currency bloc. Should such an event come to pass, it said in a statement, it "would set off a chain of financial sector shocks ... that policymakers could only contain at a very high cost."

Moody’s also pointed to the possibility that the three countries, along with other top-rated eurozone members, would have to kick in more money for possible Spanish and even Italian bailouts to continue to support the euro region, which would have a strong negative effect on their economies.

“Given the greater ability to absorb the costs associated with this support,” Moody's said, “this burden will likely fall most heavily on more highly rated member states if the euro area is to be preserved in its current form.”

Finland managed to retain not only its AAA rating but also its stable outlook, thanks in part to its insistence on collateral for loans made to bailed-out eurozone countries. Also contributing to Helsinki’s strength, said Moody’s, were its small, domestically oriented banking system; fiscally conservative budget policies; and limited dependence on trade with other countries in the eurozone.

While Standard & Poor’s and Fitch both continue to rate all four countries AAA, the former with negative outlooks for Luxembourg, the Netherlands and Finland and the latter with a stable outlook for all four, Moody’s said that it would also be taking another look at France and Austria. Although both countries are rated AAA, Moody’s dropped their outlooks to negative in February.

In the report, Moody’s said that by the end of Q3 it planned to "review whether their current rating outlooks remain appropriate or whether more extensive rating reviews are warranted."

It added that all the countries "whose balance sheets are expected to bear the main financial burden of support" carry a negative outlook. Sarah Carlson, Moody’s senior credit officer, said in the report, "We are in a transitional period, and this transitional period could last for many years, and during this transitional period we do see additional pressure on the strongest nations' balance sheets, which has increased pressure on their credit standing."

Bloomberg reported that Germany was not pleased with Moody’s action, with its Finance Ministry dismissing Moody’s concerns as “not new” and adding that it remained “in a very sound economic and financial situation,” pointing to markets’ hunger for German bonds and Berlin’s record low costs to borrow.

The ministry issued a statement that said in part, “Germany will, through solid economic and financial policy, defend its ‘safe haven’ status and continue to responsibly maintain its anchor role in the eurozone. Together with its partners, it will do everything to overcome the sovereign debt crisis as rapidly as possible.”

The ministry was also critical of what it called Moody’s “short-term” concerns, saying, “The eurozone has undertaken a whole range of measures that will lead to a lasting stabilization of the eurozone.”

However, Nicolas Veron, senior fellow at Bruegel, a Brussels-based research organization, said in the report that with “Germany’s central position in the eurozone, the idea that it could be somehow isolated from the general deterioration of the euro area is not realistic.” He added, “From this standpoint, the downgrade sounds logical.”

Commerzbank Chief Economist Joerg Kraemer was quoted saying of the ratings action, “In all large industrialized countries, AAA is an endangered species. They’re all under fire.”

Luxembourg’s Jean-Claude Juncker also struck back against Moody’s move. Juncker, leader of the group of euro-area finance ministers, said Germany, the Netherlands and Luxembourg still enjoy “sound fundamentals.”

In a statement, he said, “Against this background, we reiterate our strong commitment to ensure the stability of the euro area as a whole.”

Spain, meanwhile, saw its borrowing costs rise higher even as it sank deeper into recession. On Monday its central bank reported that the economy shrank by 0.4% in Q2, compared with Q1. While Madrid did manage to sell bonds at a Tuesday auction, it had to offer the second highest yield since the euro’s inception.

Nicholas Spiro of Spiro Sovereign Strategies said of the auction in the report, "The most important takeaway from this auction is that Spain was able get all its debt out the door. Still, in March, Spain was able to issue six-month debt at a yield of under 1%, now it is paying 3.7%."

Despite the fact that EU officials agreed to shore up Spain’s banks without the money going through Madrid, markets have shown that they are not reassured and that they anticipate the country will be back for a full-scale bailout.

Should Spain topple, it could drag Italy along, as it has done for some time on rising bond yields. If both nations require bailouts, it would more than exhaust the funds available for rescue, and worried markets in anticipating the worst could make it into a self-fulfilling prophecy.

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