The Wall Street Journal
written by Javier E. David, Dow Jones newswire
Friday December 9, 2011
NEW YORK (Dow Jones)--The two big questions facing the euro zone following Friday's fiscal pact are whether it goes far enough for the European Central Bank to ramp up bond-buying and whether Standard & Poor's downgrades its ratings on member countries' debt.
As it turns out, the latter may well depend on the former.
In the run-up to Europe's debt summit this week, S&P increased the stakes by placing 15 euro-zone countries on warning for a possible downgrade. To some, the move had echoes of how the rating agency responded to the political brawl over the U.S. debt ceiling, which concluded with an 11th hour deficit-cutting deal to raise the ceiling but still prompted S&P to strip the U.S. of its coveted Triple-A rating.
In that instance, S&P seemed just as concerned about the messy political process and the lack of any will to devise an effective fiscal containment plan as it was with the plan itself.
So, will the agency be satisfied with how the Europeans dealt with their sometimes bitter divisions and got 26 members of the 27-strong European Union to agree to tighter fiscal governance or will it pull the trigger?
The good news is that, unlike the U.S., the euro zone is already well into a program of fiscal consolidation, which S&P analysts could view encouragingly.
"When S&P put U.S. ratings on watch list…there was no near-term prospect of fiscal consolidation; in Europe it's exactly the opposite," said Krishna Memani, portfolio manager and director of fixed income at OppenheimerFunds. European fiscal consolidation "will take place, it's just a question of how quickly and by how much," he said.
Ultimately, however, the outlook for euro zone debt hinges on whether the ECB is going to use its balance sheet to backstop sovereign bond markets, since investors remain highly nervous about struggling governments' ability to finance themselves. And if their borrowing costs rise, that could prompt a ratings cut.
The central bank is deeply reluctant to sacrifice price stability at the altar of fiscal balance, which it feels is the responsibility of governments. But given the risks at stake--including the once unimaginable notion of a euro breakup--the ECB could yet bite the bullet and significantly increase its purchases of government bonds.
That in turn could prevent S&P from issuing a cascade of downgrades and alleviate concerns investors have about transferring debt from one sovereign to another.
"If the ECB takes on more of a role, then the path out of this becomes far clearer than it has been for the last two years," Memani says. "They can extinguish this debt by printing money," he added.
But S&P is also worried about the underlying health of the economies in question, and that could still prompt it to take action, others say.
Eric Upin, chief investment officer at Makena Capital says the euro zone's central issue is the one most troubling to S&P: governments are spending too much money, with not nearly enough growth or revenues to support it.
Because so much sovereign debt is held by banks, this raises the stakes for nations already skirting on the edge of AAA status - primarily France, whose financial sector is sagging under the weight of government bonds gone bad. Heavily indebted countries may be forced to absorb the banking sector losses, creating a vicious cycle of rising debt levels that's likely to make credit agencies nervous.
"It appears to us that there is not enough action to stave off a downgrade," Upin said. Europe's debts "would be manageable if it were hundreds of billions, but it looks like trillions."
Less than five months after it made its dramatic decision to downgrade the biggest economy in the world, S&P has again put itself in the hot seat.
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