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US, Europe Face More Ratings Cuts in Coming Years

The string of sovereign debt downgrades in recent months could be just the beginning. The US, Europe—even Germany—could face further ratings cuts over the next three years, according to a lengthy analysis this week by Citigroup.

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The European Union got a slight reprieve late Friday as Standard & Poor's backed it's triple-A/A-1+ rating on the EU. It had been under review and at risk of a downgrade. The outlook remains "negative."

In announcing its decision, S&P said the EU "benefits from multiple layers of debt-service protection sufficient to offset the current deterioration we see in member states' creditworthiness."

The US is at the top of Citi's list for possible downgrades because its debt and deficit troubles are unlikely to be resolved with the political infighting in Washington.

Some of the other usual suspects also are on Citi’slist – the European peripheral nations in particular such as Greece and Spain.

But even mighty Germany, seen as the continent’s most secure economy, could face a downgrade as the sovereign debt crisis escalates and a European recession spreads through the region.

“We expect a string of further ratings downgrades for advanced-economy sovereign debt, and do not expect any ratings upgrades,” Citi analysts Michael Saunders and Mark Schofield wrote.

That includes American debt, which Standard & Poor’s downgraded in August in a move that set off a more than 600-point one-day selloff in the Dow industrials.

“Failure to agree on a full-year extension of payroll tax relief and long-term jobless benefits in December has reinforced worries that ideological divides in Congress will prevent progress toward fiscal consolidation anytime soon,” Citi’s Robert V. DiClemente and Brett Rose said. “Longer-term current policy projections show federal debt levels spiraling upward as entitlement caseloads and health care costs rise.”

Citi said it is keeping its outlook unchanged on US debt in the near term but sees trouble looming for the American rating over the next two to three years.

Indeed, the list of potential downgrades is ominous and serves as a reminder that while the U.S. equity markets seem conveniently to have forgotten about the world’s debt troubles, some stern and punitive reminders are on the way.

Further downgrades for the U.S., and the initial downgrade for Germany, could be a few years away.

But in the next six months, the ratings agencies are likely again to start rattling their sabers, starting with the declaration of a Greek default that is approaching a near-certainty in March.

In fact, in the next six months,Citi expects Moody’s to cut ratings for Italy, Spain, Portugal and Greece, with the nascent recovery in Ireland allowing it to be the only one of the “PIIGS” nations to escape the downgrade scalpel.

Additionally, France and Austria are deemed likely for a “negative outlook,” while Greece will be placed into either “selective default” or “outright default.”

Going out further, the next two to three years are likely to see downgrades not only to the US but also to Japan, France, Italy, Spain, Austria, Belgium, Finland, the Netherlands and Portugal.

And that’s not all.

Both Germany and the United Kingdom – relative stalwarts through the crisis so far – are starting at possible cuts in their respective outlooks to “negative” in the next two to three years.

A German cut would be startling because it has managed to maintain fiscal discipline and avoid the debt troubles of its neighbors. The UK, meanwhile, would also raise eyebrows because it had the prudence to decline membership in the European Union’s currency zone, keeping the pound and not being as constrained in monetary policy as those countries using the euro.

“If the sovereign debt crisis escalates further, we think the rating agencies are likely to put Germany’s AAA status on negative outlook as well in the course of this year,” Citi’s Jurgen Michaels and Robert Crossley wrote.

The analysts said Germany’s contributions to the Eurozone bailout funds and banking system support make it susceptible to budget pressures as well, with the outcome “depending on the crisis escalation.”

So is anybody safe?

Citi says the only real European havens from downgrades will be Switzerland, Denmark, Norway and Sweden.

Globally, the picture also is narrow.

Only Canada, “some smaller European economies, and the Antipodean countries” – a reference generally to Australia and New Zealand – seem safe from the downgrade doom.

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