Nobody cares if a country's credit rating gets cut, so why listen to the agencies at all?

Credit ratings agencies are wrong, confused and frequently completely ignored

Bloomberg reported on a new study yesterday evening, showing the effects of a credit rating agency cutting its rating of a sovereign's debt is not what many expect it to be. 

Almost half the time, government bond yields fall when a rating action suggests they should climb, or they increase even as a change signals a decline, according to data compiled by Bloomberg on 314 upgrades, downgrades and outlook changes going back as far as 38 years. The rates moved in the opposite direction 47 percent of the time for Moody’s and for S&P. The data measured yields after a month relative to U.S. Treasury debt, the global benchmark.

The British experience is one of the key case studies in the piece, and we are actually one of the better examples of the ability of ratings agencies to move the market. On the chart below, the first orange flag is when Moody's said that the UK should implement severe cuts to keep it's Aaa rating, and the second is when our Aaa rating was put on negative outlook. Bad news would be expected to move the line up:

Yup, the markets pretty much ignored Moody's. Not quite as embarrasing as the French experience. In this case, the first orange flag is Standard and Poor's reaffirming the country's AAA rating and the other three are, respectively, a warning of a downgrade, a downgrade, and being put on negative outlook:

So the good news was followed by a steady rise in the spread, and the bad news was followed by sharp drops. Gee, I sure hope my country doesn't get downgraded by a ratings agency!

Not that any of this news is particularly new. Bloomberg even cite an IMF study from January which came to much the same conclusion:

In a January analysis of Moody’s rating changes, researchers at the IMF used credit derivatives to show that prices moved in the expected direction 45 percent of the time for developed countries and 51 percent for emerging economies. For outlook changes, the ratios were 67 percent and 63 percent.

The IMF study, by going into a bit more detail, reveals a bit of what's going on. Notice that the effect of outlook changes was significantly stronger than the effects of actual downgrades. As Felix Salmon points out, one of the strengths of markets is that they are very good at pricing in future events. When an outlook changes, a downgrade is likely to follow, and so a lot of the expected spike in yields happens before the actual downgrade.

But the other reason why the ratings agencies are ignored so often is that they simply aren't very good, particularly when dealing with countries like the UK and US, which control their own currencies. As Jonathan Portes has written time and again:

When it comes to rating sovereign debt, they simply do not know what they are talking about; worse than that, they do not even understand what their own credit ratings mean.

Ratings agencies are frequently ignored because it is nigh-on impossible to parse their ratings into actual claims. They aren't discussing increased risk of default; and nor are they discussing the risk of investing in gilts, because what they cut ratings for is frequently good for gilts (low growth, for instance, makes gilts a better deal). And the Bloomberg piece even closes with a quote which demonstrates the agencies' own cluelessness:

"The U.K. shouldn’t care at all what its rating is,” says Vincent Truglia, managing director of New York-based Granite Springs Asset Management LLP and a former head of the sovereign risk unit at Moody’s. “A rating is not what you’re supposed to be interested in. You’re supposed to be interested in the right public policy.”

If the UK shouldn't care about its own rating, then the fact that Moody's issues ratings phrased as guidance to governments – like the warning in 2010 that the UK needed to implement "severe cuts" to maintain its Aaa rating  – is very strange indeed. Ultimately, Truglia is just trying to shift the blame for the disastrous outcomes caused by policies his organisation recommended and threatened governments into implementing.

Credit ratings agencies: Falling over all the time? Photograph: Getty Images

Alex Hern is a technology reporter for the Guardian. He was formerly staff writer at the New Statesman. You should follow Alex on Twitter.

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Why the Liberal Democrats by-election surge is not all it seems

The Lib Dems chalked up impressive results in Stoke and Copeland. But just how much of a fight back is it?

By the now conventional post-Brexit logic, Stoke and Copeland ought to have been uniquely inhospitable for the Lib Dems. 

The party lost its deposit in both seats in 2015, and has no representation on either council. So too were the referendum odds stacked against it: in Stoke, the so-called Brexit capital of Britain, 70 per cent of voters backed Leave last June, as did 62 per cent in Copeland. And, as Stephen has written before, the Lib Dems’ mini-revival has so far been most pronounced in affluent, Conservative-leaning areas which swung for remain. 

So what explains the modest – but impressive – surges in their vote share in yesterday’s contests? In Stoke, where they finished fifth in 2015, the party won 9.8 per cent of the vote, up 5.7 percentage points. They also more than doubled their vote share in Copeland, where they beat Ukip for third with 7.3 per cent share of the vote.

The Brexit explanation is a tempting and not entirely invalid one. Each seat’s not insignificant pro-EU minority was more or less ignored by most of the national media, for whom the existence of remainers in what we’re now obliged to call “left-behind Britain” is often a nuance too far. With the Prime Minister Theresa May pushing for a hard Brexit and Labour leader Jeremy Corbyn waving it through, Lib Dem leader Tim Farron has made the pro-EU narrative his own. As was the case for Charles Kennedy in the Iraq War years, this confers upon the Lib Dems a status and platform they were denied as the junior partners in coalition. 

While their stance on Europe is slowly but surely helping the Lib Dems rebuild their pre-2015 demographic core - students, graduates and middle-class professionals employed in the public sector – last night’s results, particularly in Stoke, also give them reason for mild disappointment. 

In Stoke, campaign staffers privately predicted they might manage to beat Ukip for second or third place. The party ran a full campaign for the first time in several years, and canvassing returns suggested significant numbers of Labour voters, mainly public sector workers disenchanted with Corbyn’s stance on Europe, were set to vote Lib Dem. Nor were they intimidated by the Brexit factor: recent council by-elections in Sunderland and Rotheram, which both voted decisively to leave, saw the Lib Dems win seats for the first time on massive swings. 

So it could well be argued that their candidate, local cardiologist Zulfiqar Ali, ought to have done better. Staffordshire University’s campus, which Tim Farron visited as part of a voter registration drive, falls within the seat’s boundaries. Ali, unlike his Labour competitor Gareth Snell and Ukip leader Paul Nuttall, didn’t have his campaign derailed or disrupted by negative media attention. Unlike the Tory candidate Jack Brereton, he had the benefit of being older than 25. And, like 15 per cent of the electorate, he is of Kashmiri origin.  

In public and in private, Lib Dems say the fact that Stoke was a two-horse race between Labour and Ukip ultimately worked to their disadvantage. The prospect of Nuttall as their MP may well have been enough to convince a good number of the Labour waverers mentioned earlier to back Snell. 

With his party hovering at around 10 per cent in national polls, last night’s results give Farron cause for optimism – especially after their near-wipeout in 2015. But it’s easy to forget the bigger picture in all of this. The party have chalked up a string of impressive parliamentary by-election results – second in Witney, a spectacular win in Richmond Park, third in Sleaford and Copeland, and a strong fourth in Stoke. 

However, most of these results represent a reversion to, or indeed an underperformance compared to, the party’s pre-2015 norm. With the notable exception of Richmond’s Sarah Olney, who only joined the Lib Dems after the last general election, these candidates haven’t - or the Lib Dem vote - come from nowhere. Zulfiqar Ali previously sat on the council in Stoke and had fought the seat before, and Witney’s Liz Leffman and Sleaford’s Ross Pepper are both popular local councillors. And for all the excited commentary about Richmond, it was, of course, held by the Lib Dems for 13 years before Zac Goldsmith won it for the Tories in 2010. 

The EU referendum may have given the Lib Dems a new lease of life, but, as their #LibDemFightback trope suggests, they’re best understood as a revanchist, and not insurgent, force. Much has been said about Brexit realigning our politics, but, for now at least, the party’s new normal is looking quite a lot like the old one.