It is the function of a ratings agency to assess the risk associated with a bond issue; be it a corporate or a sovereign bond. The idea is that armed with this information, investors will be able to make an informed decision about the risks of a particular investment. The greater the perceived risk, the higher the yield that an issuer needs to pay to attract an investor. At the bottom of the ratings lie junk bonds which represent the highest perceived risk of default and at the top are AAA investment grade bonds which carry the smallest risk of default – in the eyes of the rating agency.
Credit rating at the sovereign level is critical since it dictates the costs that a nation needs to meet to service its debts. Doubts about the Spanish economy and debt problems have pushed borrowing over the 7% mark which many analysts regard as unsustainable. This has prompted Moody’s rating agency to put Germany’s credit outlook to negative – this means that they think Germany could lose its AAA status within 2 years.
Moody’s argues that Germany is at risk from a potential Greek Euro exit and may end up having to underwrite debt problems in Spain and Italy (problems it is intensifying by ratcheting up the fear component of the sovereign debt crisis). According to Moody’s a Greek Eurozone exit “would set off a chain of financial sector shocks” – no kidding. The agency also placed AAA-rated Luxembourg and the Netherlands on a similar outlook. However, Standard and Poor’s and Fitch have left Germany’s AAA rating on a stable outlook.
In response to Moody’s announcement, the German finance ministry stated that Moody’s was focusing on short-term risk and noted that: “By means of its solid economic and financial policy, Germany will retain its safe haven status and continue to play its role as the anchor in the euro zone responsibly”.
Continuing turbulence in the sovereign debt market must make the prospect of communal Eurozone bonds a more realistic possibility despite Germany’s reservations.