Germany’s borrowing costs may be below those of the US—that safest of havens—but that has not spared Berlin from being given a negative outlook by Moody’s, the credit rating agency.
Late on Monday, Moody’s put the triple A ratingsof Germany, the Netherlands and Luxembourg on review for a downgrade, citing the rumbling euro zone crisis, and the “increasing likelihood that greater collective support for other euro area sovereigns, most notably Spain and Italy, will be required”.
Although Finland was spared due to its “unique credit profile”, it was the negative outlook for Germany—the region’s largest and strongest economy—that caused eyebrows to be raised.
The German finance ministry, run by Wolfgang Schäuble, was quick to counter Moody’s warnings, saying in a statement that it would “through solid economic and financial policy, defend its ‘safe haven’ status and continue to responsibly maintain its anchor role in the euro zone”.
Although investors have long been concerned that Germany will somehow have to foot most of the bill of any comprehensive solution to the euro zone crisis, most expect that to be some way off, given Berlin’s reluctance, and have pushed German bond yields to record lows this year.
The recent strength of German Bunds, and of other relatively highly rated European government bonds, came under pressure on Monday and Tuesday—partially as a response to the Moody’s move but also because of the grim mood pervading markets.
“In essence, Moody’s is asking who pays the bill for any euro zone bailout,” says Richard Batty, an investment director at Standard Life Investment. “With Germany the strongest and largest economy in Europe, inevitably they will be forced to contribute.”
Yet investors are wary of predicting that Moody’s negative outlook on Germany could mark a turning point in the “safe haven trade”. This has meant investors fleeing equity markets and the bonds of Europe’s periphery and piling into the most highly rated securities—such as German Bunds.
“Germany losing its triple A rating would be a blow, but would it really matter to most investors? Not really, most already know that Germany will have to pay for any clean-up of the crisis,” says Jim Irvine, head of fixed income at Henderson Global Investors. “I wouldn’t want to call the end of the safe haven trade quite yet.”
Although Germany’s composite 10-year bond yield edged up 8 basis points on Monday to 1.25 percent, it is still not far from record lows. The two-year bond yield is still firmly negative.
Past predictions that German bond yields have bottomed out have also proven premature. The 10-year bond yield hit a record low of 1.127 percent on June 1, before rising to 1.64 percent by June 20, as investors started to price in the cost of a comprehensive euro zone rescue in some form or fashion.
But since then, Berlin’s borrowing costs have fallen near record lows again as investors sought the relative safety of Bunds.
Indeed, investors say that in a financial world where even the US does not command a triple A from all rating agencies, having the top grade is not necessary to be considered a relatively safe investment.
For example, Standard & Poor’s, another major rating agency stripped France and Austria of their triple-A grades in mid-January, but the bonds of both countries have rallied strongly since then.
In fact, investors are currently more concerned about the prospect of Italy and Spain losing their investment grades, than a slight trimming of the ratings of the euro zone’s stronger members. Many funds and central banks can only buy the debts of countries rated investment grade, and a downgrade to “junk” could erode their potential buying base.
“That could force some funds out of their position, and hurt these markets further,” Mr. Irvine warns.
Nonetheless, investors and strategists agree with Moody’s broader assessment that the euro zone crisis—and the likely solution through bailouts and debt mutualization—are in the long run likely to weigh on the creditworthiness of Germany and the other stronger European countries.
“This is the rating agencies trying to be ahead of the game for once,” says Michelle Bradley, a ratings strategist at Credit Suisse. “It reflects the fact that at some point there needs to be more credit risk priced into these government yields to reflect the cost of bailouts. At the moment any credit risk is swamped by safe haven inflows, but it cannot last forever.”