Thursday, March 11, 2010

S&P warns over America’s top-tier rating

Original posted in the Financial Times by David Oakley and Michael Mackenzie:

The triple A rating of the US is at risk, S&P has warned, unless the country adopts a credible medium-term plan to rein in fiscal spending.

In a report published on Thursday, the ratings agency said that there were risks that “external creditors could reduce their US dollar holdings, especially if they conclude that eurozone members are adopting stronger macroeconomic policies”.

This could undermine the dollar’s status as the global reserve currency, it said, an outcome which would “weigh on the triple A rating on the US”.

“In our opinion, fiscal outturns, inflation figures, trade volumes, foreign exchange volatility and the current account will be the leading indicators if the dollar’s role were to diminish,” S&P said.

But the ratings agency said that the US could lose its reserve currency status and still hold on to its triple A rating. It added that the loss of a currency reserve status has historically been a gradual process, taking place over decades in the case of UK, for example.

Finally, it countered that there is currently no other currency to challenge the dollar. “The euro is the only currency that could do so as China’s currency is not fully convertible for capital transactions, let alone an option as a reserve currency,” S&P said.

In a separate report, S&P warned that Europe’s leading economies face a big jump in interest rate costs from the potential threat of rising bond yields over the next five years.

With central banks withdrawing emergency financial support from the markets and bond supply rising sharply, Europe’s developed countries face additional interest rate charges totalling €202bn by 2015, according to S&P.

France, Italy, the UK and Germany face the biggest jump in borrowing costs of €41bn, €38bn, €31bn and €29bn respectively, assuming a sustained 3 percentage point rise in interest costs.

S&P said that the impact of central banks phasing out, over 2010, liquidity support to the financial sector including quantitative easing measures, will lead to a big drop in demand for government debt.

This is likely to lead to steep rises in benchmark government yields, putting pressure on financing costs as governments struggle with vast debt burdens taken on to stimulate their economies.

The ratings agency said European governments’ medium to long-term borrowing will likely hit a peak at €1,446bn in 2010. This is up €52bn from the previous peak of €1,394bn in 2009.

In net terms, in 2010 it expects the UK to be the largest sovereign borrower in Europe, at an estimated €189bn, compared with Germany, which it estimates will borrow the least among the big economies, at €64bn in net terms.

Another concern is rollover risk, or the risk of having to refinance maturing debt. S&P warns that debt-rollover ratios (the amount of long-term debt maturing plus the previous year’s stock of short-term debt) are high and still rising in many countries.

Rollover ratios exceed 20 per cent of gross domestic product for Belgium and Italy, and just below that level for Ireland and Portugal.

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