Only Part of Moody's Downgrades Were Significant

Leave it to rating agencies to cause more trouble for the financial markets. For the past few weeks, investors were cautiously optimistic that Greece would finally rid itself of its near term troubles by securing a second bailout payment from the Eurozone. Even though the EUR/USD ended the North American trading session only slightly higher against the U.S. dollar, the persistent gains in equities indicated that in general, investors remain optimistic. Unfortunately this optimism was completely sapped in early Asia by rating agency Moody's decision to cut the long term credit rating of 6 European countries. Moody's also lowered the credit outlook to negative for the U.K., France and Austria which means they are next in line to be downgraded if credit conditions in the region deteruirate. Although Moody's decision is not a complete surprise because they had been actively reviewing the ratings of these countries for the past few months, it could not have come at a worse time because investors were already questioning the sustainability of the euro's rally. When everyone is nervous and unsure about what could transpire next, it does not take a particularly large straw to break the camel's back.

The British pound was hit much harder by the news than the euro because they were the first to put U.K. on credit watch negative. In contrast, even after today's downgrade Moody's still rates Italy and Portugal one notch higher than S&P. The main difference in the Eurozone is the rating of Spain - Moody's lowered Spain's credit rating by 2 notches to A3, one notch lower than S&P. Moody's is the trailblazer in terms of warning about the risks of investing in Britain. They felt that "while the UK enjoys 'safe haven' status, there is growing risk that the weaker macroeconomic outlook could damage market confidence."

Moody's rarely has the same degree of tenacity when it comes to lowering the ratings of key countries as S&P and for this reason, once the dust settles investors will probably take their decisions with a grain salt. Nearly all of their moves simply aligns them with other rating agencies. Earlier this year, S&P stripped France of their AAA rating and all Moody's did today was change the country's outlook to negative. The rating agency's decision was motivated by their concern about the region's ability to deal with their fiscal crisis, the increasingly weak macroeconomic prospects and the impact all of this would have on implementation of domestic austerity programs, market confidence and funding conditions. Unlike the ECB who may be encouraged by the recent easing of credit conditions, rating agencies are still very worried about the risks that lie ahead this year and if they are right 1.26 may not be the bottom in the EUR/USD.

Moody's actions can be summarized as follows:

- Austria: outlook on Aaa rating changed to negative

- France: outlook on Aaa rating changed to negative

- Italy: downgraded to A3 from A2, negative outlook

- Malta: downgraded to A3 from A2, negative outlook

- Portugal: downgraded to Ba3 from Ba2, negative outlook

- Slovakia: downgraded to A2 from A1, negative outlook

- Slovenia: downgraded to A2 from A1, negative outlook

- Spain: downgraded to A3 from A1, negative outlook

- United Kingdom: outlook on Aaa rating changed to negative