Downgrading poses problems for speculators and investors
Several economies, including the USA, have had their debt ratings cut. Zoe Fiddes looks at how this impacts on confidence in the markets
With global economies treading water in a sea of debt, the three largest rating agencies, Standard & Poors (S&P), Fitch and Moody's, have been busy downgrading governments.
These agencies evaluate the creditworthiness of governments that issue treasury bonds. A bond is a debt security where, in exchange for loaned cash, the issuer owes the holder a debt for a specified amount of time and is obliged to pay interest on this debt. AAA is considered the highest rating with AA, A, BBB, BB, B, etc, following on a sliding scale.
Moody's played catch-up with other rating agencies last week by downgrading Japan due to the country's large budget deficits. However, what is of more concern is the downgrading of the world's largest economy, the United States, which lost its perfect AAA status earlier this month.
The S&P announced that they lowered their long-term sovereign credit rating on the US to AA+ from AAA, stating that the downgrade reflects their opinion that the recently agreed fiscal consolidation plan falls short of what would be necessary to stabilise the government's medium-term debt dynamics.
Several countries in the eurozone have also had their economies downgraded with the country of note being Greece, whose rating was cut by three notches to CCC, and many fearing this may lead to a D (default) rating.
Given the downgrade despair, speculators and investors are finding it hard to choose where to put their funds based on long-term outlooks.
Take gold for example, a week ago you would have been quietly confident to remain in a long (buy gold) position, however, unless you can wear a $200 price drop off the highs, you will not be smiling now.
Traders are nervous, which means they are favouring shorter term moves into and out of safe havens.
Despite the dark and stormy cloud over the global economy, there are patches of light trying desperately to get through.
In a report last week, UBS announced it had lowered its forecast of global growth in 2012 to 3.3% from 3.8%, based on lower GDP forecast for Europe and Asia. However, it does not believe that the US or wider world economy will re-enter recession. Is that a sigh of relief? I think probably not. We, the investors, are not going to believe it until we see economic figures improve consistently. After all, we are searching for a reason to be optimistic.
Britain's rating outlook is currently set at stable. Markets have been impressed with the fiscal tightening in place which suggests that any downgrade will not be sudden. The biggest risk to the UK is weak growth.
Britain, like many other countries, has a huge deficit including a current account deficit. This does not sit well with a slowdown in growth; hence the government will have to keep their tight grip on fiscal policies until the economy picks up.
With the Bank of England's decision to cut the UK 2011 growth forecast from 1.8% to 1.5% cent we could, unfortunately, be facing the harsh tax increases and tough cuts in public spending until at least some time into 2012.