Eurozone sovereign bond ratings

Here is an update of a previous table with the addition of EZ ratings from Canadian firm DBRS (Dominion Bond Rating Service).  DBRS do not provide a rating for all EZ countries but their ratings can be important as shown below.

This Bloomberg article from July 2011 explains how the ECB uses the ratings from these four companies.

The ECB determines the size of the premium, or so-called haircut, it applies to government bonds on the basis of the best credit rating from four companies -- Standard & Poor’s, Moody’s Investors Service, Fitch Ratings and DBRS. DBRS currently rates Ireland at A, two steps higher than the grades of S&P and Fitch and four steps above that of Moody’s.

DBRS’s rating means the ECB applies a 3 percent haircut on fixed-coupon Irish bonds with a residual maturity of five to seven years and a 4 percent premium on paper that will expire in seven to 10 years. Bonds rated BBB+ to BBB-, like those of Portugal, incur premiums of as much as 9 percent, as does debt from Greece, which is accepted as collateral independently of its rating.

Last week’s confirmation by DBRS of the A(low) rating for Ireland meant we ‘dodged a bullet’ in the words of this Wall Street Journal post

Canadian rating firm DBRS Inc. just showed the little guy still matters.  The fourth-biggest rating company downgraded Spanish and Italian government debt late Wednesday, and affirmed its stance on Irish bonds.

With the “big three” controlling around 95% of the global ratings market, DBRS doesn’t command the same attention. But when it comes to the euro-zone’s financially troubled countries, it should.

Because the European Central Bank listens to DBRS just as it does to the others.  DBRS is one of the four ratings firms the ECB uses when deciding how much it charges investors for using sovereign bonds as collateral in exchange for loans.

Luckily for those keen to avoid shakeouts in euro-zone bond markets, DBRS still rates those governments in the “A” category, with an “A (low)” for Spain and Ireland only one notch into the area. Italy is three notches above at an “A (high).”

Cutting them below an A-rating level would have spurred the ECB to charge 5% more for using Spanish and Irish government bonds as collateral.

DBRS have Italy at “A” rather than “A(high) as stated in the article.  Also the ECB’s collateral framework is set to be overhauled in September which may change the significance of these ratings.

Eurozone sovereign bond ratings

Today’s downgrade of Italian government bonds by ratings agency Moody’s was a little unexpected.  Here is a table of the rating of all 17 eurozone members with the three main ratings agencies, Standard and Poors, Fitch and Moody’s. 

The ratings classifications along the left hand side are used by S&P and Fitch (though they do give them different descriptions) while those on the right are used by Moody’s.

It is starting to get a little crowded at the towards the bottom of the investment grades.  Greece and Portugal have “junk” status with all three agencies.  Ireland was given a similar status by Moody’s this time last year.  Twelve months later than could be viewed as a premature move by the agency.

S&P have Ireland at the same ratings notch as Spain and Italy while with Fitch Ireland is one notch below Italy and is actually one grade above Spain.  This relative ranking is not maintained by Moody’s which has below both (two notches below Italy and one below Spain).

The only other instance where there is not a consistent relative ranking across the three agencies is Malta’s rating with S&P.  Both Fitch and Moody’s have Malta as least as high or above all of Estonia, Slovakia and Slovenia.  S&P have Malta below all three.

Moody’s could, of course, come into line with the other two in the relative ranking of Ireland, Italy and Spain.  However to do this, Moody’s would, of course, have to bring Italy and Spain to “junk” status as this is the only way they could have a rating equal to or below Ireland’s current Ba1 rating with them. 

This could happen but the junking of either Italy or Spain would be a major event.  Alternatively, Moody’s could upgrade Ireland to investment grade status but an increase in the sovereign bond rating of any eurozone country would be an equally noteworthy event. 

There is little to suggest that such an upgrade is warranted unless it was to acknowledge that the initial downgrade to “junk” status was a bit hasty.  And ratings agencies could never make a mistake, could they?

Fitch keeps Ireland at BBB+

For the second time in a fortnight a ratings review has seen Irish government bonds hold their rating at BBB+.  According to Fitch:

BBB ratings indicate that expectations of credit risk are currently low. The capacity for payment of financial commitments is considered adequate but adverse business or economic conditions are more likely to impair this capacity.

The Fitch statement on the ratings decision begins

The affirmation of Ireland's sovereign ratings primarily reflects two factors:

- Whilst Fitch has reduced the score assigned to capture financing flexibility in its assessment of the credit profile of those eurozone sovereigns that have large fiscal financing needs and significant financial/economic imbalances, in Ireland's case its 'BBB+'/'F2' rating had already incorporated this lack of financing flexibility as demonstrated by it losing market access in 2010 .

- Ireland's progress with fiscal and structural adjustment under the IMF-EU programme. Notwithstanding the intensification of the eurozone crisis over the last months, on-track fiscal performance and the improvement of macroeconomic and financial fundamentals led to the decline of interconnected fiscal sustainability and financial stability risks and all programme targets have been met.

Not a lot to generate much reaction here though I must have missed “the improvement of macroeconomic fundamentals”.  Economic growth? Inflation? Unemployment?  There has been some stability but hardly enough to warrant description as an improvement.  The full statement is below the fold.

The strong political support behind the multi-year fiscal consolidation plan and the broader public acceptance of its necessity are key supports to the adjustment process. According to preliminary data, the 2011 deficit-to-GDP ratio was better than the 10.6% target set in the IMF-EU programme with current official estimates suggesting the deficit came in at just under 10%. Fitch believes the 2012 target of 8.5% is attainable, not least due to the lowering of the interest rate on the EU portion (a total of EUR 40.2bn by 2013) of the official loans.

Export-driven recovery characterised the first half of 2011. While domestic demand is still contracting, the flexibility of the Irish economy, in particular the cut in nominal wages and prices resulting in a sharp improvement of competitiveness, helped to take advantage of strong external demand in early 2011.

Overall, financial stability concerns have receded following the PCAR exercise in March 2011. Market confidence has increased in Irish financial institutions, as evidenced by deposit stabilisation in H211 following previous sharp declines, successful raising of private capital by the Bank of Ireland and wholesale funding transactions. Following the public recapitalisation of the sector by EUR63bn, the capital adequacy ratios of the three largest banks are among the highest in the eurozone, providing a sizeable buffer for the expected losses. However, downside risks remain - non-performing loans are still rising, property prices have yet to reach a bottom and low mortgage foreclosure rates suggest further adjustment lies ahead.

Nevertheless, significant external headwinds persist. The Negative Outlook reflects the exposure to the economic downturn of major European trading partners, a key concern given the export-oriented growth model of the Irish economy, and the adverse impact of heightened eurozone financial tension on Irish financing conditions. In particular, the timing and interest rate level of the sovereign's return to market financing remains uncertain, although the recent bond switch aiming at smoothing the maturities between 2014 and 2015 is an encouraging sign.

Contagion from further intensification of the eurozone crisis or a material slippage of the fiscal consolidation path, either due to looser fiscal policy stance or a significant deterioration of the growth trajectory, could lead to a negative rating action. On the contrary, the successful implementation of the IMF/EU programme, a return to sustainable economic growth, and the moderation of the eurozone crisis would stabilise the rating Outlook.

The legislative process of the adoption of the fiscal compact represents a new and country-specific risk for Ireland. The Irish authorities may be required to hold a referendum on the fiscal compact. In light of the initial Irish 'No' to the EU Treaty in the June 2008 referendum, Fitch finds the probability of another rejection non-negligible. The uncertainty that would be created by another such 'No' vote would put further pressure on the rating.

S&P keeps Ireland at BBB+

For the second time since August, S&P has reaffirmed its BBB+ rating for Irish government bonds.  BBB+ is two grades above junk status and is defined as “adequate capacity to meet financial commitments, but more subject to adverse economic conditions”.  In August, though, the outlook was Stable, now it is Negative.  That implies there is a one-in-three chance of a downgrade over the next two years.

Italy, Portugal and Spain all had two-notch downgrades.  Italy has been moved to BBB+ and now stands alongside Ireland.  Portugal, which previously had a BBB- lowest investment grade rating, now has a junk status grade of BB.  Spain began at AA- and is now at A.  As with Ireland the outlook on all of these is Negative.  The last of the PIIGS, Greece, did not form part of the current review and remains at the low-junk CC grade and a disorderly default is a growing possibility.

A lot of the current S&P statement explaining the decision on Ireland deals with the general eurozone environment but there are some interesting country-specific elements.   Two of these are:

1.  All other things being equal, we view the government's fiscal consolidation plan as sufficient to achieve a general government deficit of around 3% of GDP in 2015.

2.  We expect the general government net debt burden to fall to about 103% of GDP in 2015, having peaked at 109% in 2013. Our net debt estimates include the impact of the government's €64 billion (40% of GDP) in banking sector recapitalizations during 2008-2011 and €29 billion (18% of GDP) in debt issued by the National Asset Management Agency (NAMA) as of end-2011.

In August they were forecasting that their measure of net debt would peak at 110% of GDP in 2013.  That has now being reduced to 109% of GDP (possibly as a result of the double-counting error in the Department of Finance.)  The 103% net debt/GDP for 2015 is unchanged.  On the general eurozone response to the crisis they state:

1. In our opinion, the political agreement [the fiscal compact of December 9th] does not supply sufficient additional resources or operational flexibility to bolster European rescue operations, or extend enough support for those eurozone sovereigns subjected to heightened market pressures.

2. [.] we believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating, as domestic demand falls in line with consumers' rising concerns about job security and disposable incomes, eroding national tax revenues.

The full text of the S&P statement is below the fold.

LONDON (Standard & Poor's) Jan. 13, 2012--Standard & Poor's Ratings Services today affirmed the 'BBB+' long-term and 'A-2' short-term ratings on the Republic of Ireland. At the same time, we removed the long-term rating from CreditWatch with negative implications, where it was placed on Dec. 5, 2011. The outlook on the long-term ratings is negative.

Our transfer and convertibility (T&C) assessment for Ireland, as for all European Economic and Monetary Union (eurozone) members, is 'AAA', reflecting our view that the likelihood of the European Central Bank restricting nonsovereign access to foreign currency needed for debt service is extremely low. This reflects the full and open access to foreign currency that holders of euro currently enjoy and which we expect to remain the case in the foreseeable future.

The outcomes from the EU summit on Dec. 9, 2011, and subsequent statements from policymakers lead us to believe that the agreement reached has not produced a breakthrough of sufficient size and scope to fully address the eurozone's financial problems. In our opinion, the political agreement does not supply sufficient additional resources or operational flexibility to bolster European rescue operations, or extend enough support for those eurozone sovereigns subjected to heightened market pressures. 

We also believe that the agreement is predicated on only a partial recognition of the source of the crisis: that the current financial turmoil stems primarily from fiscal profligacy at the periphery of the eurozone. In our view, however, the financial problems facing the eurozone are as much a consequence of rising external imbalances and divergences in competitiveness between the eurozone's core and the so-called "periphery." As such, we believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating, as domestic demand falls in line with consumers' rising concerns about job security and disposable incomes, eroding national tax revenues. 

However, we have not adjusted the political score of the Republic of Ireland down. This is a reflection of our view that the Irish government's response to the significant deterioration in its public finances and the recent crisis in the Irish financial sector has been proactive and substantive. This offsets our view that the effectiveness, stability, and predictability of European policymaking and political institutions (with which Ireland is closely integrated) have not been strengthened so as to match the severity of the broadening and deepening financial crisis in the eurozone.

Excluding government-funded banking sector recapitalization payments, the authorities have adjusted the budget by almost €21 billion (13% of estimated 2012 GDP) since 2008 and plan additional fiscal savings of some €12.4 billion (7.8% of GDP) for 2012-2015. All other things being equal, we view the government's fiscal consolidation plan as sufficient to achieve a general government deficit of around 3% of GDP in 2015. In our view, there is currently a strong political consensus behind the fiscal consolidation program and policy implementation so far has been extremely strong. In the face of a weaker-than-expected outlook for economic growth, additional measures (€0.2 billion, 0.1% of GDP) have been introduced to meet the government's targets.

We expect the general government net debt burden to fall to about 103% of GDP in 2015, having peaked at 109% in 2013. Our net debt estimates include the impact of the government's €64 billion (40% of GDP) in banking sector recapitalizations during 2008-2011 and €29 billion (18% of GDP) in debt issued by the National Asset Management Agency (NAMA) as of end-2011. NAMA's purpose is to acquire, hold, and dispose of land and property; it has acquired and is now working out eligible assets from participating financial institutions. Should NAMA asset disposals progress more rapidly than our current assumption (10% of GDP over 2013-2015), the government's net debt burden could improve at a faster pace.

In our view, Ireland has a flexible and very open economy. This is illustrated by the 25% depreciation in the trade-weighted exchange rate between May 2008 and October 2011 (latest data) and by goods and services exports estimated at about 113% of GDP in 2012. Partly as a result of these factors, as well as the noncyclical nature of a substantial part of Irish exports, net export growth has contributed positively to the muted Irish economic recovery in 2011. However, in our view this also leaves the Irish economy and, ultimately, the Irish government's fiscal consolidation program, susceptible to worsening external economic conditions. This is reflected in our downside hypothetical scenario, which contemplates real GDP per capita economic growth, general government deficits, and general government net debt averaging 0.9%, 6.6%, and 114% of GDP, respectively, over the 2012-2015 period, compared with our base-case scenario of 1.7%, 6.1%, and 107%.

We have lowered our assessment of Ireland's external score. On Dec. 5, 2011, we said that this score was unlikely to change as our concerns raised with regard to a sudden stop in interbank funding had already been realized in Ireland. However, the Irish government and Irish financial institutions have not had access to the capital markets for unsecured long-term funding since early 2010. Our assessment of the sovereign's external risks has been updated to reflect this.

DBRS downgrades Ireland to A(low)

Yesterday, the Canadian rating agency, Dominion Bond Rating Service or DBRS downgraded Ireland from A to A(low).  The ratings used by DBRS can be viewed here.  Just six weeks DBRS had confirmed Ireland A rating and suggested it was “unlikely to downgrade Ireland”.

However the A(low) rating from DBRS is four grades above speculative or "junk" status and remains Ireland's highest rating among the four leading ratings agencies.  As we know both S&P and Fitch have Ireland three notches above junk with their rating of BBB+, while Moody's lowered Ireland's rating one notch below the junk status threshold to BB+ in early July.

We previously looked at S&P’s recent statement on Ireland and their forecasts of Ireland’s “net government debt including NAMA obligations”.  To make comparisons different DBRS focus on “gross government debt excluding NAMA” but they have the following to say:

In our revised baseline scenario, Ireland’s gross general government debt peaks at 120% of GDP in 2013 and gradually declines thereafter. This excludes NAMA bonds and its associated assets.

Although difficult to draw exact comparisons there is agreement that Ireland’s debt ratios will peak over the next few years.  The full DBRS statement can be read here. 

One benefit of maintaining the A rating with DBRS on Irish government bonds for our ailing banks is highlighted here.

When Moody’s downgraded Ireland to junk status on the 12th of July their statement clearly stated that the basis for the decision was the belief that “private sector creditor participation will be required as a precondition for additional support” from the EU/IMF. 

When emerging from the crisis summit nine days later Michael Noonan clearly stated that there would be no such pre-conditions as long as Ireland was meeting the terms of the original agreement.  Moody’s themselves admit that Ireland has met, and in some cases exceeded, the targets laid out in the EU/IMF programme.  In the light of recent developments the Moody’s downgrade to junk status does not seem warranted.

In fact if Moody’s were to listen to the views of Fitch just a few days earlier they may not have gone as far.  In a comment the following is stated.

Ireland is unlikely to default on its debt, Chris Pryce, a sovereign credit analyst with Fitch Ratings, said today.

“Our ratings, which are investment grade reflect the view that we certainly don't believe that Ireland is likely to default,” Pryce said in a telephone interview today. Fitch has a BBB+ rating on Ireland.

S&P downgrades US bonds to AA+

After a day of speculation Standard and Poor’s have officially downgraded US government debt from the top rating AAA to AA+.  Here is the full list of S&P ratings.  Everything from BBB- up is considered investment grade, with ratings from BB+ down given speculative or junk status.

Yesterday, S&P confirmed Ireland investment grade status of BBB+.  Here are the bullet points that accompanied the S&P statement. (The full statement is reproduced below the fold.)

• We have lowered our long-term sovereign credit rating on the United States of America to 'AA+' from 'AAA' and affirmed the 'A-1+' short-term rating.
  We have also removed both the short- and long-term ratings from
  CreditWatch negative.
• The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government's
  medium-term debt dynamics.
• More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011.
• Since then, we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government's debt dynamics any time soon.
• The outlook on the long-term rating is negative. We could lower the long-term rating to 'AA' within the next two years if we see that less reduction in spending than agreed to, higher interest rates, or new fiscal pressures during the period result in a higher general government debt trajectory than we currently assume in our base case.

There was some debate that the figures used by S&P t0 justify the downgrade were incorrect.  S&P came out and admitted that the numbers were wrong but argued that the revision did not change their overall view.  See clarification statement here.

The full S&P statement on the US downgrade is below the fold.

TORONTO (Standard & Poor's) Aug. 5, 2011--Standard & Poor's Ratings Services said today that it lowered its long-term sovereign credit rating on the United States of America to 'AA+' from 'AAA'. Standard & Poor's also said that the outlook on the long-term rating is negative. At the same time, Standard & Poor's affirmed its 'A-1+' short-term rating on the U.S. In addition, Standard & Poor's removed both ratings from CreditWatch, where they were placed on July 14, 2011, with negative implications.

The transfer and convertibility (T&C) assessment of the U.S.--our assessment of the likelihood of official interference in the ability of U.S.-based public- and private-sector issuers to secure foreign exchange for debt service--remains 'AAA'.

We lowered our long-term rating on the U.S. because we believe that the prolonged controversy over raising the statutory debt ceiling and the related fiscal policy debate indicate that further near-term progress containing the growth in public spending, especially on entitlements, or on reaching an agreement on raising revenues is less likely than we previously assumed and will remain a contentious and fitful process. We also believe that the fiscal consolidation plan that Congress and the Administration agreed to this week falls short of the amount that we believe is necessary to stabilize the general government debt burden by the middle of the decade.

Our lowering of the rating was prompted by our view on the rising public debt burden and our perception of greater policymaking uncertainty, consistent with our criteria (see "Sovereign Government Rating Methodology and Assumptions ," June 30, 2011, especially Paragraphs 36-41). Nevertheless, we view the U.S. federal government's other economic, external, and monetary credit attributes, which form the basis for the sovereign rating, as broadly unchanged.

We have taken the ratings off CreditWatch because the Aug. 2 passage of the Budget Control Act Amendment of 2011 has removed any perceived immediate threat of payment default posed by delays to raising the government's debt ceiling. In addition, we believe that the act provides sufficient clarity to allow us to evaluate the likely course of U.S. fiscal policy for the next few years.

The political brinksmanship of recent months highlights what we see as America's governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy. Despite this year's wide-ranging debate, in our view, the differences between political parties have proven to be extraordinarily difficult to bridge, and, as we see it, the resulting agreement fell well short of the comprehensive fiscal consolidation program that some proponents had envisaged until quite recently. Republicans and Democrats have only been able to agree to relatively modest savings on discretionary spending while delegating to the Select Committee decisions on more comprehensive measures. It appears that for now, new revenues have dropped down on the menu of policy options. In addition, the plan envisions only minor policy changes on Medicare and little change in other entitlements, the containment of which we and most other independent observers regard as key to long-term fiscal sustainability.

Our opinion is that elected officials remain wary of tackling the structural issues required to effectively address the rising U.S. public debt burden in a manner consistent with a 'AAA' rating and with 'AAA' rated sovereign peers (see Sovereign Government Rating Methodology and Assumptions," June 30, 2011, especially Paragraphs 36-41). In our view, the difficulty in framing a consensus on fiscal policy weakens the government's ability to manage public finances and diverts attention from the debate over how to achieve more balanced and dynamic economic growth in an era of fiscal stringency and private-sector deleveraging (ibid). A new political consensus might (or might not) emerge after the 2012 elections, but we believe that by then, the government debt burden will likely be higher, the needed medium-term fiscal adjustment potentially greater, and the inflection point on the U.S. population's demographics and other age-related spending drivers closer at hand (see "Global Aging 2011: In The U.S., Going Gray Will Likely Cost Even More Green, Now," June 21, 2011).

Standard & Poor's takes no position on the mix of spending and revenue measures that Congress and the Administration might conclude is appropriate for putting the U.S.'s finances on a sustainable footing.

The act calls for as much as $2.4 trillion of reductions in expenditure growth over the 10 years through 2021. These cuts will be implemented in two steps: the $917 billion agreed to initially, followed by an additional $1.5 trillion that the newly formed Congressional Joint Select Committee on Deficit Reduction is supposed to recommend by November 2011. The act contains no measures to raise taxes or otherwise enhance revenues, though the committee could recommend them.

The act further provides that if Congress does not enact the committee's recommendations, cuts of $1.2 trillion will be implemented over the same time period. The reductions would mainly affect outlays for civilian discretionary spending, defense, and Medicare. We understand that this fall-back mechanism is designed to encourage Congress to embrace a more balanced mix of expenditure savings, as the committee might recommend.

We note that in a letter to Congress on Aug. 1, 2011, the Congressional Budget Office (CBO) estimated total budgetary savings under the act to be at least $2.1 trillion over the next 10 years relative to its baseline assumptions. In updating our own fiscal projections, with certain modifications outlined below, we have relied on the CBO's latest "Alternate Fiscal Scenario" of June 2011, updated to include the CBO assumptions contained in its Aug. 1 letter to Congress. In general, the CBO's "Alternate Fiscal Scenario" assumes a continuation of recent Congressional action overriding existing law.

We view the act's measures as a step toward fiscal consolidation. However, this is within the framework of a legislative mechanism that leaves open the details of what is finally agreed to until the end of 2011, and Congress and the Administration could modify any agreement in the future. Even assuming that at least $2.1 trillion of the spending reductions the act envisages are implemented, we maintain our view that the U.S. net general government debt burden (all levels of government combined, excluding liquid financial assets) will likely continue to grow. Under our revised base case fiscal scenario--which we consider to be consistent with a 'AA+' long-term rating and a negative outlook--we now project that net general government debt would rise from an estimated 74% of GDP by the end of 2011 to 79% in 2015 and 85% by 2021. Even the projected 2015 ratio of sovereign indebtedness is high in relation to those of peer credits and, as noted, would continue to rise under the act's revised policy settings.

Compared with previous projections, our revised base case scenario now assumes that the 2001 and 2003 tax cuts, due to expire by the end of 2012, remain in place. We have changed our assumption on this because the majority of Republicans in Congress continue to resist any measure that would raise revenues, a position we believe Congress reinforced by passing the act. Key macroeconomic assumptions in the base case scenario include trend real GDP growth of 3% and consumer price inflation near 2% annually over the decade.

Our revised upside scenario--which, other things being equal, we view as consistent with the outlook on the 'AA+' long-term rating being revised to stable--retains these same macroeconomic assumptions. In addition, it incorporates $950 billion of new revenues on the assumption that the 2001 and 2003 tax cuts for high earners lapse from 2013 onwards, as the Administration is advocating. In this scenario, we project that the net general government debt would rise from an estimated 74% of GDP by the end of 2011 to 77% in 2015 and to 78% by 2021.

Our revised downside scenario--which, other things being equal, we view as being consistent with a possible further downgrade to a 'AA' long-term rating--features less-favorable macroeconomic assumptions, as outlined below and also assumes that the second round of spending cuts (at least $1.2 trillion) that the act calls for does not occur. This scenario also assumes somewhat higher nominal interest rates for U.S. Treasuries. We still believe that the role of the U.S. dollar as the key reserve currency confers a government funding advantage, one that could change only slowly over time, and that Fed policy might lean toward continued loose monetary policy at a time of fiscal tightening. Nonetheless, it is possible that interest rates could rise if investors re-price relative risks. As a result, our alternate scenario factors in a 50 basis point (bp)-75 bp rise in 10-year bond yields relative to the base and upside cases from 2013 onwards. In this scenario, we project the net public debt burden would rise from 74% of GDP in 2011 to 90% in 2015 and to 101% by 2021.

Our revised scenarios also take into account the significant negative revisions to historical GDP data that the Bureau of Economic Analysis announced on July 29. From our perspective, the effect of these revisions underscores two related points when evaluating the likely debt trajectory of the U.S. government. First, the revisions show that the recent recession was deeper than previously assumed, so the GDP this year is lower than previously thought in both nominal and real terms. Consequently, the debt burden is slightly higher. Second, the revised data highlight the sub-par path of the current economic recovery when compared with rebounds following previous post-war recessions. We believe the sluggish pace of the current economic recovery could be consistent with the experiences of countries that have had financial crises in which the slow process of debt deleveraging in the private sector leads to a persistent drag on demand. As a result, our downside case scenario assumes relatively modest real trend GDP growth of 2.5% and inflation of near 1.5% annually going forward.

When comparing the U.S. to sovereigns with 'AAA' long-term ratings that we view as relevant peers--Canada, France, Germany, and the U.K.--we also observe, based on our base case scenarios for each, that the trajectory of the U.S.'s net public debt is diverging from the others. Including the U.S., we estimate that these five sovereigns will have net general government debt to GDP ratios this year ranging from 34% (Canada) to 80% (the U.K.), with the U.S. debt burden at 74%. By 2015, we project that their net public debt to GDP ratios will range between 30% (lowest, Canada) and 83% (highest, France), with the U.S. debt burden at 79%. However, in contrast with the U.S., we project that the net public debt burdens of these other sovereigns will begin to decline, either before or by 2015.

Standard & Poor's transfer T&C assessment of the U.S. remains 'AAA'. Our T&C assessment reflects our view of the likelihood of the sovereign restricting other public and private issuers' access to foreign exchange needed to meet debt service. Although in our view the credit standing of the U.S. government has deteriorated modestly, we see little indication that official interference of this kind is entering onto the policy agenda of either Congress or the Administration. Consequently, we continue to view this risk as being highly remote.

The outlook on the long-term rating is negative. As our downside alternate fiscal scenario illustrates, a higher public debt trajectory than we currently assume could lead us to lower the long-term rating again. On the other hand, as our upside scenario highlights, if the recommendations of the Congressional Joint Select Committee on Deficit Reduction--independently or coupled with other initiatives, such as the lapsing of the 2001 and 2003 tax cuts for high earners--lead to fiscal consolidation measures beyond the minimum mandated, and we believe they are likely to slow the deterioration of the government's debt dynamics, the long-term rating could stabilize at 'AA+'.

On Monday, we will issue separate releases concerning affected ratings in the funds, government-related entities, financial institutions, insurance, public finance, and structured finance sectors.

Bond yields fall and S&P are happy

After a year of almost unrelenting increases Irish government bond yields have been falling for the past two weeks.  The recent drop only goes some way to offsetting the increases that took place over the past year.  Here is the 10-year bond yield constructed by Bloomberg.

Although the recent drop has been rapid, the 10-year yield is only back to where it was at the end of April.  There is still a long way to go before these yields give any indication that Ireland can return to raising funds on bond markets.

That would require a drop to around 5% or so.  As it is we have yet to drop below 10%, but dropping through this level is something that could happen in the next day or so.  Trading today has seen the yield hover around 10.2%.

The movements in Irish bond yields are running counter to all of other fellow PIIGS (Portugal, Italy, Greece, Spain) who are continuing to see rising yields, albeit only moderately.   The actual yields and yesterday’s closing prices off all Irish government bonds can be seen in this daily report from the NTMA.

[UPDATE: The Irish ten-year yield produced by Bloomberg finished the day at 10.024%. Chart here.  Getting below 10% is not far away.  It finished as a reasonably good day for the PIIGS with only Greece seeing rising yields on the day.]

The news on Ireland today was further boosted by a statement from S&P this morning confirming our BBB+ investment grade rating for Irish government bonds with a stable outlook.  BBB is two notches above speculative or junk status and is defined as “adequate capacity to meet financial commitments, but more subject to adverse economic conditions”.

Here is the S&P view of Ireland’s public debt:

We expect Ireland's net general government debt burden will peak at about 110% of GDP in 2013, including NAMA's debt obligations, before falling to about 103% of GDP in 2015. Excluding NAMA obligations, we expect net debt to peak at around 97% of GDP in 2014.

This is a long way from what some domestic commentators are trying to predict.  The full S&P statement is reproduced below the fold and in general it is reasonably positive.

The ratings on the Republic of Ireland reflect our view of the government's commitment and capacity to stabilize public finances following a severe banking crisis and a structural deterioration in the fiscal balance. We believe that Ireland's creditworthiness is sustained by a strong political consensus in favor of fiscal consolidation, which should reduce the general government deficit to around 3% of GDP by 2015. We also view Ireland's competitiveness gains since late 2008 and open economy as being supportive of modest, export-led economic growth over the medium term.

In our opinion, the Irish government's fiscal strategy should be capable of putting the public finances on a more sustainable path. Following the Heads of State or Government of the Euro Area and EU Institutions statement of July 21, 2011, we expect the interest rate on the European Financial Stability Facility (EFSF: foreign currency AAA/Stable/--) portion (€17.7 billion) of Ireland's €67.5 billion external support package to decrease to about 4.5%, from about 6.0%. We estimate the saving to the Irish government on interest payments will be around €0.9 billion (0.6% of GDP) cumulatively over 2012-2015. The maturities on EFSF loans are also expected to be lengthened as part of the Heads of State agreement. Meanwhile, it is also possible that interest rate reductions will be extended to Ireland's European Financial Stability Mechanism (€22.5 billion) and bilateral borrowings (€4.8 billion).

In our view, the Irish government has sufficient funding under its external support package to cover its financing requirements until the second half of 2013. At this time we expect Ireland will look to refinance a €11.9 billion bond maturing Jan. 15, 2014. We expect Ireland's marginal funding costs at this time to have declined to rates of around 6% or lower, a level that in our view would not put the government's debt dynamics at risk. Such funding rates would, we believe, be commensurate with the Irish government's success at convincing the capital markets that its primary fiscal balance and growth prospects are sufficient to put the public finances on a more sustainable path. On the other hand, any failure to meet these fiscal targets or to restore growth of the domestic economy could imply locking-in higher nominal interest rates, which we believe would likely damage debt sustainability.

As well as attempting to halve the 2010 structural deficit of around 10% of GDP by 2015, the Irish authorities are also contending with the aftermath of a severe banking crisis. In our view, the assumptions underlying the central bank's Financial Measures Programme were robust (see "Ireland's Ratings Lowered To 'BBB+/A-2' And Removed From CreditWatch; Stable Outlook Reflects Credibility Of Stress Test," April 1, 2011) and we do not expect any further material costs to the government of supporting the domestic banking system over and above the €64 billion (41% of GDP) in capital already injected and the €28 billion (18% of GDP) in National Asset Management Agency (NAMA: local currency BBB+/Stable/A-2) debt securities issued (see Related Research below).

We expect Ireland's net general government debt burden will peak at about 110% of GDP in 2013, including NAMA's debt obligations, before falling to about 103% of GDP in 2015. Excluding NAMA obligations, we expect net debt to peak at around 97% of GDP in 2014.

In our view, Ireland is the most open economy in the euro area, with exports estimated to exceed 105% of GDP and on track to expand an estimated 7% in volume terms this year. In absolute terms, Ireland's merchandise trade balance, which hit an all-time high of US$48 billion (31% of GDP) in 2010, is the third highest in the euro area, despite Ireland's position as the twelfth-largest economy in the EU-17. Due to its openness, Irish output is sensitive to any potential external demand shocks, as well as to the level of the real exchange rate (which has been depreciating due to declining nominal wages). Most of the gross value added from Ireland's export sector gets transferred abroad via dividend payments. Moreover, the international tradables sector has so far contributed little in the form of new employment to the Irish economy. Nevertheless, the second round impact of the export sector on job creation, domestic incomes, and public finances should not be understated.

Standard & Poor's projects that Ireland's real per capita GDP will increase by 0.3% during 2011, driven exclusively by net exports and accelerating toward 2.0% by 2014. We expect real domestic demand will continue to decline until 2013 and could be further depressed as the European Central Bank (ECB) embarks on a monetary policy tightening cycle. At end-2010, 86% of Irish residential mortgages carried flexible interest rates. Meanwhile, external demand could also weaken.

The 'AAA' T&C assessment, which applies to all EMU members, reflects Standard & Poor's view that there is an extremely low risk of the ECB restricting access to foreign exchange needed for debt service.

The stable outlook reflects our view of the balanced risks to Ireland's creditworthiness. However, if the government doesn't achieve its fiscal strategy, downward pressure on the ratings could build. Alternatively, were the economy to return more quickly to average real GDP per capita growth rates above our current expectation of 1.6% during 2011-2015, we could consider raising the ratings.