Moody's downgrades France and Slovakia amid fiscal and political challenges

Markets

German and EMU yields on Friday initially only showed minor gains, but finally extended the rebound that gradually developed earlier last week. US yields added 5.4 bps (2-y) to 6.9 bps (10-y). There were no important US data, but markets apparently are pondering whether recent solid US activity data, slightly higher inflation and uncertainty on the inflationary impact of future (fiscal) policy, might cause the Fed to turn more conditional on the pace and timing of additional cuts. The new (most likely upwardly revised) dot plot will be instructive on the MPC policy assessment going forward. German yields continued the ‘technical’ post-ECB rebound, rising about 5 bps across the curve; the very long end slightly outperforming (30-y +3.4bps). First post-meeting comments from ECB policy makers showed the usual divide between ‘hawks’ and ‘doves’. However, for now gradualism is the greatest common denominator. Despite a congruent interest rate move between the US and EMU, EUR/USD tried to leave recent lows, but the move lacked conviction (close 1.0501 from 1.0468). Sterling underperformed both the dollar and the euro after disappointing UK October production data and a negative monthly GDP reading (-0.1% M/M for the second consecutive month).Earlier last week, it looked like EUR/GBP was heading for a test of the key 0.8203 2022 low. On Friday, the pair closed north of 0.83(22). The technical picture remains fragile, but there is some breathing space. Equities in Europe and the US closed little changed.

Asian markets mostly trade in negative territory after China reported weak November retail sales (3% Y/Y vs 5% expected), indicating ongoing weak demand growth despite recent stimulus efforts. US yields decline marginally as does the dollar (DXY 106.85, EUR/USD 1.053). Later today, the focus will be on the EMU preliminary PMI’s. Given ongoing political uncertainty in France and Germany and persistent negative headlines on all kinds of economic topics, it’s probably too early to see any sustained improvement yet (consensus sees 49.5 unchanged composite PMI). Weak data might already cap any further rise in short-term EMU yields. 2.20%/2.25 % might provide resistance for the 2-y swap short-term. The picture at the longer and of the curve is more balanced. For the US, we look out whether the services PMI confirms the decline in the services ISM. There are often discrepancies between the two indicators. For the euro (EUR/USD), the EMU data might be the dominant factor short-term. First ST resistance at 1.063 is far away. After Friday’s poor UK data, sterling might become more sensitive to additional negative news (consensus expects composite PMI at 50.6 from 50.5).

News and views

Rating agency Moody’s downgraded both France (Aa2 to Aa3, stable outlook) and Slovakia (A2 to A3, stable outlook) after Friday’s market close. The decision to downgrade France reflects the view that the country's public finances will be substantially weakened over the coming years because political fragmentation is more likely to impede meaningful fiscal consolidation. A negative feedback loop between higher deficits, a higher debt load and higher financing costs, against the backdrop of significant annual borrowing needs, could be the unwanted outcome. Moody’s expect the deficit to stand at 6.3% of GDP in 2025, before gradually decreasing to around 5.2% in 2027. Debt-to-GDP would increase from 113.3% in 2024 to around 120% in 2027. The decision to downgrade Slovakia's ratings reflects the country's broad institutional challenges amid political tensions. A comprehensive reform programme on the judiciary and the media will weaken the country's checks and balances, amplifying a deteriorating trend already captured in governance indicators. At the same time, increased political fragmentation challenges policymaking in particular on the fiscal front.

The German CDU’s election manifesto will be formally unveiled tomorrow, but the Financial Times in an article comments on a draft it has seen from the poll-leading Christian Democrats. The want to run amongst others on a platform of tougher immigration – “we must decide ourselves once again who comes to us and who can stay” – and an agenda for hard-workers. Proposals include cuts to income tax for people on low- and middle-incomes, a reduction in social security contributions, a gradual decline in corporate taxation from about 30% now to 25% and abolishing the “Soli” surcharge on income tax that was introduced to pay for German reunification. It’s unclear how they would fund these rebates with the CDU staying committed to the debt brake. “The debts of today are the taxes of tomorrow.”

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