Notes From Underground: Moody’s Hits France With A Yellow Card

Well, Moody’s downgraded the France’ sovereign rating from AAA in what was an obvious bow to reality. MOODY’s, WHAT TOOK YOU SO LONG? This will really be a bitter pill for President Hollande as it was only last week that the “French cock” was crowing about how well the bond markets were evaluating his performance as the leader of France. I reminded readers that the recent performance of the French debt had more to do with Mr. Draghi’s aggressive actions than any policy put forward by the Hollande government.

In the Moody’s statement about the downgrade it cited the following concern about France:

The risk that greater collective suport will be required for weaker euro area sovereigns has been rising, most for notably Spain whose economy and the government bond market are around twice the combined size of those of Greece, Portugal and Ireland. HIGHLY RATEDMEMBER STATES ARE LIKELY TO BEAR A DISPROPORTIONATELYLARGE SHARE OF THIS BURDEN GIVEN THEIR GREATER ABILITY TO ABSORB THE ASSOCIATED COSTS. (emphasis mine)

It seems that Moody’s is terrified of the adverse feedback loop that will affect a fragile French economy. The greater the economic downturn in the euro zone caused by the German-demanded austerity budgets, the more negative impact on France. The ESM is a construction of all the EU members and thus will drain the French treasury in an effort to meet its regional obligations. If President Hollande is to provide more cash for bailouts and still meet his 3% deficit number, it will mean even greater cut backs for the domestic economy.

The proof will be in what the markets do to the French/German debt spreads as President Hollande advised us last week. At today’s close, the German/French 10-year bond spread was a 72 basis point differential. This will be a point of reference going forward.

***While remaining in Europe, Reuters News ran an interesting story, “Germany Floats idea of Greek 25-cent-on Euro debt buy back.” It seems that Germany is proposing that private sector debt holders sell their remaining Greek debt (about 30% of the total) at 25% of face value and the Greeks will be lent the money by the Troika so it can buy in high-yielding debt and contract some of the onerous interest payments. The Germans maintain that the official sector cannot take a haircut on their holdings for that would violate the present EU treaty on financing sovereign bailouts. The EU authorities would then move to lower the interest rates on Greek debt that the ECB and EFSF now holds.

As the interest rate is lowered, the maturity of the loans would lengthen, thus effectively doing a major restructuring and granting the Greeks more “time,” and alleviating the immediate budget pressures. This is as close to a 1980s sovereign debt restructuring as we have seen. The only question is: WILL THE PRIVATE DEBT HOLDERS OBLIGE OR PRESS FOR A BETTER DEAL? There will be a “game of chicken” as some of the hedge funds are now sure that the EU/Germany will not let Greece go as the price of default for the EU system is too great relative to the cost.

The German’s are just searching for the immediate price from private debt holders. Greece is small change compared to what Spain will cost–so get the easy one out of the way and prepare for a much bigger problem. If the private debt holders accept it, this will be deemed a positve by the markets,bat least for the moment. Time to return to the May 2010 articles by Buchheit and Gulati: “How to restructure Greek Debt.”

***Tonight, the Bank of Japan will announce its interest rate decision.mThe consensus is for NO CHANGE, as elections are called for December 16 and Governor Shirakawa will not want to play in the political arena at this time. Besides, the YEN has weakened by 3% since the last meeting so the immediate pressure on the BOJ is off. More importantly, the LDP, the main opposition to the present government, is making the BOJ a major issue for the upcoming election. LDP leader Shinzo Abe has made noises about changing the banking laws so as to limit BOJ independence.

This is a lot of noise as the Japanese will not wish to undermine the BOJ’s global stature, especially in a time when central bank Independence is so highly valued by the markets. The Japanese are great engineers but they do not do well as trend setters. If the world’s financial elite value the BOJ’s reputation it will not be in the LDP’s interest to upset the present situation. There are other ways for an ABE-led government to put downward pressure on the YEN as the Ministry of Finance has authority over the currency’s value.

The BOJ can certainly make the path easier for the MOF, but it need not sacrifice its independence in allowing the YEN to weaken. If the BOJ does not announce any change to its liquidity program, the market may rally the YEN so have your levels in place to sell any sizable rally. The NIKKEI has been a good indicator for YEN weakness so if the Japanese equity markets hold above the 200 day m.a. it will be a good sign for continued YEN weakness.

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