Why is the Downgrade of European Countries’ Debt Important?


The Euro zone problems have been in the news for months, if not years. Bond yields have been going higher for the PIIGS countries (Portugal, Ireland, Italy, Greece and Spain) for quite a while indicating more risk of default, and more problems issuing debt. Austerity measures have also been in the news for a while as a means to try to alleviate this issue. Yet the downgrade of eight European countries’ debt caused an initial negative reaction in the markets. Why is this? Is it because these downgrades are news? Is it the timing of the announcements? Is it the magnitude of the downgrades issued? The ratings agencies seem to have a lot of influence, but for what reasons? The idea that the European nations have a difficult time paying debts is not a new idea, and it has been well known and discounted in the markets for quite a while. Markets normally account for such events quickly, and yet for rating agencies it is not the case. Usually, when bad news is confirmed, markets rally because it is “sell on rumour, buy on news” when the direction is negative. Did this not happen in this case because these ratings confirm the worst scenario and there is no going back? Couldn’t ratings be upgraded again to show an improvement in a country fiscal position? It is perhaps that these downgrades affect future issuances of debt and must be announced officially for the effect to take place? In that case, if a country has an issue paying debt and this has been signaled in the media for years, why would this be such a concern? (1)(2)(3)(4)(5) We will see what the future brings.

 

Sources:

1)                  http://www.bloomberg.com/news/2012-01-15/euro-falls-after-s-p-strips-france-of-aaa-reduces-eight-others-ratings.html

2)                  http://www.bloomberg.com/news/2012-01-04/france-seeks-lower-yield-at-bond-sale.html

3)                  http://www.bloomberg.com/news/2012-01-13/pound-heads-for-weekly-loss-against-the-euro-on-bets-europe-crisis-abating.html

4)                  http://www.bloomberg.com/news/2012-01-13/u-k-stocks-rally-on-optimism-euro-area-debt-crisis-is-easing.html

5)                  http://www.bloomberg.com/news/2012-01-14/merkel-says-downgrades-show-euro-leaders-must-redouble-efforts.html

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About joetheinvestor
Joe Barbieri has Bachelors degrees in both Civil Engineering and Commerce from the University of Toronto. He has worked in the Financial Services field for over 12 years, covering positions from Retail Customer Service and Fund Accounting, through to Investment Research on the Institutional side. He has worked in 5 companies, spanning banks, a mutual fund, a Consulting Firm and a Large Canadian Pension Plan. He currently has a Chartered Financial Analyst designation (CFA) from the CFA Institute. He has recently published articles in Pension and Benefits Monitor Magazine as well as the Internet.

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