U.S. Sovereigns under Suspicion

Moody's downgraded Greece sovereigns and threatened to put U.S. sovereigns on negative outlook. The

(03.06.2011) Moody's downgraded Greece sovereigns and threatened to put U.S. sovereigns on negative outlook. The yield on Treasuries increased and the U.S. Dollar fell.

By Kyrre Aamdal, Senior Economist at DNB Markets

Yesterday Moody's Investors Service said that if there is no progress on increasing the statutory debt limit in coming weeks, it expects to place the US government's rating under review for possible downgrade, due to the very small but rising risk of a short-lived default. The U.S. Congress has out a limit on the Governments total debt, and the limit is already reached. The Treasury has said that if the debt ceiling is not increased by the beginning of August, the government will be in a default position.

Normally the Congress would increase the debt limit, but in today's situation the Republicans make the most of its majority to force the Obama administration to accept budget cuts. Moody's said that if the debt limit is raised and default avoided, the Aaa rating will be maintained. However, the rating outlook will depend on the outcome of negotiations on deficit reduction. A credible agreement on substantial deficit reduction would support a continued stable outlook; lack of such an agreement could prompt Moody's to change its outlook to negative on the Aaa rating. Although Moody's fully expected political wrangling prior to an increase in the statutory debt limit, the degree of entrenchment into conflicting positions has exceeded expectations. The heightened polarization over the debt limit has increased the odds of a short-lived default. If this situation remains unchanged in coming weeks, Moody's will place the rating under review.
 
Wednesday Moody's Investors Service downgraded Greece's local and foreign currency bond ratings to Caa1 from B1, and assigned a negative outlook to the ratings. The rating action concludes the review for possible downgrade that the rating agency initiated on 9 May 2011. There are two main triggers for Wednesday's downgrade.

First
, the increased risk that Greece will fail to stabilize its debt position, without a debt restructuring, in light of (1) the ever-increasing scale of the implementation challenges facing the government, (2) the country's highly uncertain growth prospects and (3) a track record of underperformance against budget consolidation targets.

Second, the increased likelihood that Greece's supporters (the IMF, ECB and the EU Commission, together known as the "Troika") will, at some point in the future, require the participation of private creditors in a debt restructuring as a precondition for funding support. "Taken together, these risks imply at least an even chance of default over the rating horizon", Moody's said in a statement. Moody's points out that, over five-year investment horizons, around 50% of Caa1-rated sovereigns, non-financial corporate and financial institutions have consistently met their debt service requirements on a timely basis, while around 50% have defaulted. Greece's Caa1 rating incorporates Moody's assumption that current negotiations between the Greek government and the Troika will result in further official support for the Greek government and the announcement of additional austerity and structural reform measures. The negative outlook on the Caa1 rating reflects Moody's view that the country's very large debt burden, the significant implementation risks in its structural reform package, and the country's ongoing need for external support skew risks of future rating actions to the downside.
 
According to unofficial reports Greece and the Troika have agreed upon the fundamental features in a new agreement with funding for Greece until 2014. The details are planned to be discussed at then summit meeting 20 June. These reports may have curbed the increase in yields for Greece's sovereigns after the Moody's downgrading.
 
Today U.S. non-farm payroll is expected to increase by 164', down from last month's 244'. The ADP figures Wednesday surprised by a growth of only 38' versus expectations of 175'. Along with the figures for initial claims we think there is a downside risk on the non-farm payrolls.