Focus on junk to keep attention away from ratings shifts

S&P cited deteriorating growth prospects as the key factor in its decision. Following markets’ muted reaction to France’s recent downgrade and the Dutch cut, the question is, does losing a AAA rating really matter?

In deciding to downgrade the sovereign, the agency said the Netherlands’ growth prospects were weaker than previously anticipated, and the real gross domestic product per capita trend growth rate “was lower than that of peers at similarly high levels of economic development”. The agency said weaker growth prospects would “make it more challenging for the government to achieve its fiscal targets, [and] we believe that the policy consensus in favour of containing public debt and deficits will be maintained”.

Almost certainly at the core of S&P’s decision lay soft consumer demand, which has limited the economy’s capacity to achieve levels of growth reached before 2008. The agency said consumer spending had been dampened by high household debt levels and falling house prices.

Household indebtedness was 110 per cent of Dutch GDP at June 30 2013 and “house prices have fallen by 20 per cent from their peak, and we expect a further small decline in 2014”, said S&P. With unemployment rising and consumption already depressed, the reality facing the sovereign is that spending will most likely remain low and tax receipts weaker than anticipated.

With fewer top-rated sovereigns left in the eurozone, indeed globally, one questions the importance of these shifts. Perhaps what has happened is that a shift in the order of magnitude has occurred. The sovereign crisis in Europe appears to have dramatically changed the way in which markets view sovereign ratings and the way in which markets apply their sensitivities to those sovereigns and the ratings downgrades.

Ahead of the crisis, a downgrade from AAA would have resulted in significant market stress. Today, the reaction is weak unless pressure falls on countries nearer the threshold to junk – countries that are large, systemically important and unable perhaps to fund themselves on an on-going basis.

Seemingly, these questions, and the sensitivities attached to the countries with ratings that may see them junked and thus off the table for many investors have become far more pertinent than the loss of AAA. Spain has already proved this point. Italy may be the next to reiterate it.

Matthew Cairns is senior credit strategist at AXA Investment Managers