European Union Debt Downgrade

A European Union debt downgrade could be catastrophic for the EU debt dilemma, say many observers. These comments arise as ratings agencies threaten downgrades in debt rating of all nations using the Euro. After a week of positive news and stock market rallies, comments from debt rating agencies raise the prospect of a worse recession in the European Union. Oil futures fell at the prospect of decreased economic activity tied to the continuing inability of EU officials to come up with a solution to the sovereign debt crisis. It seems ironic that just a couple of years ago Fitch, Moody’s, and Standard and Poor’s were all roundly criticized for not staying on top of the sorry state of many financial institutions prior to the 2008 market collapse. Now, officials would like the ratings agencies to be a little less diligent. In fact the EU has set up a watch dog agency to oversee the overseers.

The European Securities and Markets Authority (ESMA) has been seen to be making inquiries of Standard & Poor’s, Moody’s and Fitch. This is happening as EU officials blame ratings agencies for worsening the financial crisis. Some have pointedly remarked that the ratings agencies could be punished if their “methodology” is found to be politically motivated and not driven by financial and economic fundamentals. As the debt crisis continues in Europe, officials seem to be casting around for a scapegoat and the ratings agencies may well be in a no win situation. The agencies will likely be criticized for a European Union debt downgrade or for neglecting to adjust their ratings in the face of the obvious.

The fact that German factory orders rose recently, after successive declines, should give heart to those expecting that the EU will wrestle its way out of the debt dilemma. However, the crisis has simmered for over a year without a resolution and traders and investors seem to jump at every new piece of news. Stocks, commodities, and the Euro have been especially chaotic. A European Union debt downgrade, if it comes, may simply be another piece of news on the way to an eventual resolution of this problem.

As news of a possible European Union debt downgrade takes the front page the US Federal Reserve is looking at just how much risk big US banks have in the Euro via currency swaps. The Fed is also said to be helping provide financial stimulus in the EU in order to keep credit flowing. Investors and currency traders were reassured last week by comments made by the leaders of both Germany and France to the point that they will not let the EU collapse. In fact, US stocks had their best week in two years. Many trading the Euro versus other currencies in this ongoing crisis have chosen to purchase options, calls, and puts, on the Euro in order to hedge the inherent currency risk. Although selling options tends to be more profitable over the long run the current situation with a possible European Union debt downgrade is fraught with risk and is best left to large financial institutions with very deep pockets.