Of Rules, Rubes, and Rubicons

Yesterday Moody’s downgraded some European debt. Does anybody care?

On the face of it, a lot of investors care. Yields on 5-year Portuguese bonds rose 2.8%. Some folks think it’s because this change has made a lot of people care who would rather be spending time on the beach, but the reality is a little more messy.

Portuguese bonds are still rated investment grade by S&P and Fitch, although they are watch-listed for a downgrade by Fitch. There’s no forced selling —yet. The downgrade wasn’t surprising, although the severity was. Before yesterday the bonds were Baa1; Moody’s downgraded them to Ba2: four notches. And in their comments they said the jury is still out on Portugal. In spite of a severe austerity plan that has been supported by the newly sworn-in government, Moody’s wants to get in front of this one, in spite of the tough plan the Portuguese just put in place.

So Portuguese debt is being repriced on bond desks across Europe because the suits at Moody’s finally decided to get tough. But if the other ratings agencies follow along—and they almost have to, now—what will happen? Auditors under orders following simple checklists will force banks to take capital charges and sell into a weak market regardless of the economics. The one-way market (down) makes things worse, at least in the short term. This always happens when there’s a significant downgrade.

But just because Moody’s says something doesn’t make it so. The viability of Portugal depends on the Portuguese. That doesn’t make Moody’s wrong—but they’re no Rubicon.

Douglas R. Tengdin, CFA
Chief Investment Officer
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