Credit Rating Downgrade: The Economic Red Flag

By Jan 19, 2009, 1:23 PM Author's Blog  

This morning, Standard and Poors downgraded the sovereign debt rating of Spain from AAA to AA+. With Greece’s rating downgraded last week and Ireland and Portugal on credit watch negative, this could be the beginning of more downgrades.

Therefore it is important to consider what it means for a country to have their credit rating downgraded:

To have your credit rating downgraded means higher costs of borrowing. The Euro is slipping as we are seeing an exodus out of Spanish bonds because some global funds are mandated to invest only in AAA debt. A credit rating reflects the risk of default. Therefore a lower credit rating means that a country is at greater risk of defaulting on their debt.

On a local level, we expect investors to shift their money out of Spanish debt and into countries with a higher credit rating such as Germany or even outside of the Eurozone. Spanish Bond prices have dropped significantly since the beginning of the year, driving yields higher. The gap between the interest rates on German and Spanish bonds have hit the highest level in 10 years, reflecting the sharp divergence in economic performance. Talk of Spain leaving the Eurozone is irrelevant because their cost of borrowing would skyrocket if they chose to do so. I think that there is a greater chance the countries being downgraded will be kicked out of the Eurozone.

Spain-German Rates

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