Sovereign Debt

To be serious for a moment, I think it’s quite difficult to judge the impact on equities from sovereign economic news. Sometimes a poor jobs announcement in the US can have a big downside impact & other times it goes almost unnoticed. The same is true for some company announcements. I think that’s what makes following charts, value and growth so attractive as opposed to trying to fish tops and bottoms. Some mighty big hedge funds have failed from trying to anticipate the markets & calling it wrong but I don’t know of any that have failed from following the markets.

Towards the end of last year almost everyone’s attention had been focused on the worsening situation of European Sovereign debt, since then the mainstream press have had a succession of issues that have been considerably more eye-catching to report on. With our collective attention having been distracted it is worth noting yesterday’s action by Moody’s, they have downgraded Portugal’s debt from A1 to A3. With a continuing status for them as “negative outlook” further downgrades are possible.

What this means for Portugal is that in order to place their debt in the market with a lower rating, they will have to offer a more attractive coupon (the interest they offer to people who lend them money). Effectively, the bond market will expect a higher return for a riskier bond. This means the end cost of borrowing money has increased for Portugal, adding to their budgetary issues.

Part of the problem that Portugal and other European countries face is that they need to address budget deficits in order for the rating agencies to have confidence in maintaining or raising their rating. The two obvious routes to do this are through raising taxes and cutting spending. It almost goes without saying that neither course of action will win many votes for the political parties that introduce these.

As we are already aware, the Bank of England is becoming more likely to raise the UK base rate from its low level of 0.5%. The UK are fortunate in that, when the Monetary Policy Committee’s decision is made, the only consideration is what is in the best interest for the UK. Conversely, the European Central Bank have a considerably more difficult balancing act to achieve when they meet. Germany has long been the financial backbone of the EU and it would suit them to raise interest rates sooner rather than later. However, almost all of the other EU members have less stable economies and interest rate rises could easily knock these more fragile recoveries.

The need to address these issues has not gone away, we’ve just had more immediate issues to focus on. However, the urgency in which we tackle sovereign debt will become more pressing and we’ll start worrying about what is happening here again.