By Min Zeng A DOW JONES NEWSWIRES COLUMN
NEW YORK (Dow Jones)--With the governments of Ireland, Greece, Spain and Portugal all coming in for major credit ratings actions or warnings this past week, investors are starting to worry whether the next shoe to drop could be a country like Belgium--or worse, France.
For the most part, the market has treated the slew of downgrades and warnings about the four so-called "peripheral" euro-zone countries' debt as a catch-up exercise for the ratings agencies, especially Moody's Investor Service, whose statements dominated the news on sovereign ratings. The bonds of these countries have sold off in recent days but without the panic selling seen at previous moments in the euro crisis, and that's partly because the ratings announcements came as no surprise.
More alarmingly, however, the risk premiums demanded by sellers of "core" euro-zone sovereign debt have risen at the same time, with the cost of insuring the bonds of both Belgium and France now sitting near record-high levels in the credit default swap market.
In previous moments of turmoil in the euro-zone periphery, the bonds of these core countries have rallied on safe-haven inflows, led always by Germany's. That's not happening this time, however, investors are now also starting to worry about the awkward debt dynamics in these ostensibly more stable economies and the risk of contagion via their banks' holdings of peripheral countries' debt.
"The rating agencies are behind the game, but I think the great fear is that France would be downgraded next year," said David Scammell, a money manager in London at Schroders Investment Management Ltd., which manages about GBP160 billion in assets. All "euro-zone countries face structural issues including high fiscal deficits and the banking sector problem. That has gotten many people nervous."
The cost of insuring the equivalent of $10 million in five-year bonds sold by France hit a record high of $108,000 per annum on Monday, according to data provider Markit. By Tuesday, it had eased to $105,000 but that was still far higher than $95,000 on Dec. 1. Meanwhile, Belgium CDS were quoting a price of $206,000, only slightly below a record high of $208,000 hit on Dec. 10.
The three main ratings agencies put the region's debt woes back on people's radars this past week.
On Dec. 15, Moody's put Spain's government debt rating on review for a possible downgrade. The following day, it did the same to Greece's rating, as did Standard & Poors Ratings Services.
Then, on Friday, Moody's announced a sweeping five-notch downgrade in Ireland's rating to Baa1 from Aa1, leaving it just above speculative grade, or junk, status. That action was followed Tuesday by Moody's warning that it might downgrade Portugal's debt by as much as two notches and a warning from Fitch Ratings Agency that it might join its two counterparts and strip Greece of its investment grade rating.
Although market prices had mostly anticipated these moves, further downgrades are likely to make it more costly for the fiscally strained nations of the euro-zone periphery to borrow in capital markets. That in turn, could push the euro lower and revive questions about the fate of the monetary union, all of which will weigh on the established core economies of northern Europe.
Other than Germany, key borrowing rates across the monetary union have surged to elevated levels unseen since the launch of the euro in 1999. The higher borrowing costs in turn raise default fears among investors and complicate governments' efforts to rein in fiscal deficits with austerity program.
Assessing these risks, Christoph Kind, a fund manager at Frankfurt Trust Investment GmbH in Frankfurt with $20 billion in fixed-income assets, said that while the recent actions showed the ratings agencies to be "behind-the-curve," they created the "real danger" of more downgrades to junk status. And when that happens it could spark a more aggressive sell-off in debt across the euro zone as well as for the euro.
"Buying euro zone debt now is like grabbing a falling knife," said Kind. "I wouldn't find these high yields attractive at the moment." Bonds yields move inversely to prices.
When S&P and Moody's slashed Greece's debt to junk earlier this year, fund managers had to dump holdings of the Greek government's bonds because the action removed them from benchmark bond indexes requiring investment-grade status. A similar move on the bigger economies of Portugal, Ireland or Spain would likely have a more widespread impact.
More optimistic investors are betting, however, that as the crisis widens to include euro-zone power-brokers such as France and Germany, it will force more aggressive actions from policymakers to halt the contagion.
Jack McIntyre, a fund manager from the fixed income team that manages $23 billion in global bonds for Brandywine Global Investment Management LLC in Philadelphia, said the European Central Bank could step up its buying of euro-zone government bonds, for example.
If German banks face mounting losses, Germany might even be pushed to support a plan for euro-denominated European bonds, he argued. German Chancellor Angela Merkel rejected that idea earlier this month because German taxpayers don't wish to pay a higher price for sharing the weaker fiscal positions of other sovereign bond issuers.
"Just look at the banking system in Europe," McIntyre said. "German banks have huge exposure to other euro-zone countries such as Ireland ... I think there will be more willingness from Germany to offer longer-term solutions."
(Min Zeng, a reporter at the Money desk, writes about fixed-income and forex markets for Dow Jones Newswires. He can be reached at 212-416-2229 or via email at: min.zeng@dowjones.com)
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