Catching Wild Pitchers

Moody’s downgraded Portugal Tuesday—but that’s not a huge surprise. Overall, Europe’s indicated they have the means and the desire to backstop struggling eurozone countries.

Story Highlights:

  • Moody’s downgraded Portugal Tuesday and looks likely to do the same to Ireland.
  • European officials have been frustrated with ratings agencies recently and are considering creating one of their own.
  • While Europe still faces some significant hurdles in handling peripheral debt issues, they still have tools at their disposal—and for the most part, markets aren’t too worried about wider contagion.

As baseball season hits its halfway point stateside, Europe is dealing with entirely different sorts of pitchers and backstops. Moody’s Investors Service threw the latest pitch, announcing Tuesday their downgradeof Portugal to Ba2 from Baa1 and taking Portuguese debt officially to junk status. Ireland is seemingly next, with analysts indicating its rating may also go to junk. But this is all far more like a fastball on a 3-0 count than a curveball, which can take batters by surprise. German and French yields ticked modestly down Wednesday, PIIGS yields were up, and overall, stock markets shook the news off and closed basically flat. No surprises here—recall: Portugal and Ireland were both already bailed out (by the AAA-rated EFSF) because they couldn’t finance their debt without aid (which would seemingly imply a rating like the EFSF or below investment grade).

As we’ve said before, ratings agencies are notoriously late to the financial news party. And when they arrive, they’re frequently confused. Not only that, but given their “government-approved” status, folks may mistake their word as gospel—when in actuality they’re not all that different from stock analysts (a point we’ve also made before) and subject to miscalculations and incorrect conclusions.

European frustration with credit ratings agencies has been rising recently—and somewhat understandably so. European plans and sovereign nations have been a frequent target of the oligopoly of late—like earlier this week, when S&P announcedthey would characterize the French plan for Greece(which eurozone leaders toiled over and successfully got banks to buy into) as a default, though possibly a selective default. That’s not an insurmountable obstacle to the plan, but it likely ruffled some feathers among eurozone leaders. Now, European officials are beginning to talkof unleashing market forces and creating a more European-focused and -based agency of their own. A move which may or may not help—presumably a European agency would bring challenges similar to those the extant agencies pose.

Yes, there are undoubtedly financial troubles in Portugal, and they’re different from Greece’s challenges (which are different from Ireland’s, Spain’s, etc.), meaning European officials won’t be able to apply a one-size-fits-all Band-aid. But keep in mind Portugal just elected a new government and adopted austerity measures stricter than those European standards required. Downgrading them so soon in the wake of those changes seems either late (considering extant bailouts—we already know they can’t fully cover their debts on their own) or quite premature—but not very timely. And the action potentially makes it more difficult for struggling countries like Portugal and Ireland to return to credit markets on schedule—a point European officials are beginning to make when citing ratings agencies’ problems.

But despite these issues, Europe’s indicated a willingness to do what it takes to ensure the monetary union remains intact, including the central bank accepting increasingly low-rated debtas collateral—something ECB President Jean-Claude Trichet was initially adamanthe wouldn’t do. And judging from markets’ reactions, they largely agree that core Europe, while it has much work to do to alleviate peripheral debt issues, for the most part has things in hand and still has tools available to backstop the periphery. They may need to change pitchers, but it’s certainly not the bottom of the 9th yet—they have time.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.