Last night Standard and Poor’s downgraded the credit rating of Spain to BBB-, from BBB+. This came as a bit of an early surprise for the bond markets. The market was waiting on the other major bond rating company Moody’s to complete its review of its current Baa3 rating which it started in June. Rating agencies normally take 3 months to complete their reviews, so Moody’s are late with their conclusion. S&P continues to have Spain on negative outlook, meaning that within the next 3 months they could and almost certainly will downgrade Spain to below investment grade. It seems certain that when Moody’s completes its review then it will be downgrading Spain, the fiscal situation in Spain has deteriorated beyond what Moody’s believed in June.
The market reaction is muted at the moment. If as expected Moody’s were to downgrade Spain to below investment grade, there is unlikely to be an immediate need for many fund managers to sell their bond holdings as only those benchmarked against the JP Morgan Aggregate Index (MAGGIE) would see the bonds no longer in the index. Other bond index providers, BoAML and Barclays would only see the bonds fall out of their indices if S&P followed Moody’s to have a non-investment grade rating. So whilst this is eventually likely, fund investors have probably 3 months to reduce their holdings. But selling pressure will begin to grow.
The downgrade to Junk is clearly warranted
- Official Growth targets are way above those of the rating agencies for 2013 and beyond, meaning that the fiscal metrics will fail to meet the investment grade ratios.
- The wealthy state of Catalonia will cause a constitutional crisis by calling for a referendum on secession.
- There would like be a form of debt restructuring if Spain requests aid from the ESM, the imposition of Collective Action Clauses into all outstanding debt would occur.
- A full bailout for Spain would almost certainly require more austerity and even lower growth prospects.
The bigger impact today is set to be on Spain’s financial and corporate credits, all will face downgrades by S&P here. Whilst Santander will remain investment grade, BBVA may come close to losing its investment grade status and corporates such as Telefonica are likely to lose their investment grade status. So some forced selling pressure may well surface from international investors today. Would look for Telefonica bonds to widen 30-40bp today.
As regards government bond markets, I would expect they continue to be range bound- but after a very strong 10yr US Treasury auction last night, the auction tonight of 30yr US Treasury bonds offers a good opportunity for investors to enter mid range.
I would expect that Treasuries move towards the bottom of the trading range tomorrow, 1.60% on US 10yrs and 2.77% on 30yrs.