Conclusion: Based on the potential for negative deltas across a few rather important credit ratings in a specified order, we think it will pay to stick with our King Dollar and Eurocrat Bazooka theses throughout the intermediate term.
This morning, in our firm-wide internal research meeting, Tom Tobin, Josh Steiner, and Keith McCullough all shared various thoughts on the ratings downgrade catalyst calendar. While we do not find much value in the opinions of ratings agencies, we do accept the implications that these downgrades have on market prices and financial market risk via hardwire ratings linkages with financial institutions and the perceived creditworthiness of bailout schemes such as the EFSF.
Given, we’ve decided to take the opportunity to quickly highlight what the calendar looks like on this front, which shows serious headwind of credit downgrade risk:
The recent and relevant commentary from the ratings agencies is as follows:
- Moody’s: “Moody's Investors Service has today placed on review for downgrade all subordinated, junior subordinated and Tier 3 debt ratings of banks in those European countries where the subordinated debt still incorporates some ratings uplift from Moody's assumptions of government support, with the potential complete removal of government support in these ratings. The review will affect 88 banks in 15 countries in Europe with average potential downgrades of subordinated debt by two notches and junior subordinated debt and Tier 3 debt by one notch... The review has been caused by the rating agency's view that within Europe, systemic support for subordinated debt may no longer be sufficiently predictable or reliable to be a sound basis for incorporating uplift into Moody's ratings…The banking systems and number of banks affected by the review are in the following countries: Austria (9), Belgium (3), Cyprus (2), Finland (3), France (8), Italy (17), Luxembourg (3), Netherlands (6), Norway (5), Poland (1), Portugal (2), Slovenia (2), Spain (21), Sweden (4),Switzerland (2). A list of affected institutions is attached: http://www.moodys.com/viewresearchdoc.aspx?docid=PBS_SF268891”
- Standard & Poor’s [per French newspaper La Tribune yesterday]: "It [revision to negative outlook] could happen within a week, perhaps 10 days." La Tribune further reports that it canceled at the last minute such an announcement that was originally supposed to accompany last Friday’s downgrade of Belgium. Recall that last week Fitch reiterated France’s AAA LT/LC rating, but that it would have “limited room” to absorb new fiscal shocks without endangering that status (i.e. backstopping it’s banking system or other large European sovereigns – both things France is likely to have to commit to doing in 2012).
- Fitch: “The rating Outlook on the Long-term [U.S. sovereign LT/LC debt] rating is revised to Negative from Stable… The Negative Outlook indicates a slightly greater than 50% chance of a downgrade over a two-year horizon. Fitch will shortly publish its revised economic and fiscal projections for the U.S. and will conduct a further review of its sovereign ratings in 2012. However, in the absence of material adverse shocks, Fitch does not expect to resolve the Negative Outlook until late 2013, taking into account any deficit-reduction strategy that emerges after Congressional and Presidential elections.”
As you can see from the aforementioned timing setup, we think there will be an opportunity to re-short the EUR vs. the USD (among other things) throughout the intermediate term – a view supported by this singular factor of potential negative deltas across a few rather important credit ratings in a specified order. While we would never gain conviction on any long or short position using a simple one-factor model such as this one, this is an incremental factor among a myriad of supportive data points for our intermediate-term King Dollar & Eurocrat Bazooka positioning, which is manifested in our current positioning below:
- Long the US Dollar;
- Long long-term U.S. Treasuries and a Treasury curve flattener;
- Long U.S. investment-grade corporate bonds;
- Short French equities;
- Zero percent allocation to U.S. money center banks; and
- Zero percent allocation to European equities or credit.
For the sake of brevity, we’ll keep it tight here. Email our sales team at if you’d like to dialogue further regarding any of the above; Steiner’s Financials team and Tobin’s Healthcare team have done a great deal of work regarding ratings linkages, etc. and the U.S. debt/deficit outlook.
Be mindful of that Global Macro calendar!