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Daily Market Commentary

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What Does It Mean to Have Your Credit Rating Downgraded?

Mon, Jan 19 2009, 22:34 GMT
by Kathy Lien

GFT

What Does It Mean to Have Your Credit Rating Downgraded?

This morning, Standard and Poors downgraded the sovereign debt rating of Spain from AAA to AA+ (read the commentary from our colleague Boris Schlossberg). With Greece’s rating downgraded last week and Ireland and Portugal on credit watch negative, this could be the beginning of more downgrades in the Eurozone.

Therefore it is important to consider what it means for a country to have their credit rating downgraded:

To have your credit rating downgraded means higher costs of borrowing. The Euro is slipping as we are seeing an exodus out of Spanish bonds because some funds are mandated to invest only in AAA debt. A credit rating reflects the risk of default and a lower credit rating means that a country is at greater risk of defaulting on their debt.

On a local level, we expect investors to shift their money out of Spanish debt and into countries with a higher credit rating such as Germany or even countries outside of the Eurozone. Spanish bond prices have dropped significantly since the beginning of the year, driving yields higher. The gap between the interest rates on German and Spanish bonds have hit the highest level in 10 years, reflecting the sharp divergence in economic performance. According to the following chart, the spread between German and Spanish interest rates have doubled since November. 

Talk of Spain leaving the Eurozone is irrelevant because their cost of borrowing would skyrocket if they chose to do so. We think that there is a greater chance that those countries will be kicked out of the Eurozone than leave it voluntarily.

Published on  Mon, Jan 19 2009, 22:36 GMT