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.

Photo: Getty Images
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Autumn Statement 2015: George Osborne abandons his target

How will George Osborne close the deficit after his U-Turns? Answer: he won't, of course. 

“Good governments U-Turn, and U-Turn frequently.” That’s Andrew Adonis’ maxim, and George Osborne borrowed heavily from him today, delivering two big U-Turns, on tax credits and on police funding. There will be no cuts to tax credits or to the police.

The Office for Budget Responsibility estimates that, in total, the government gave away £6.2 billion next year, more than half of which is the reverse to tax credits.

Osborne claims that he will still deliver his planned £12bn reduction in welfare. But, as I’ve written before, without cutting tax credits, it’s difficult to see how you can get £12bn out of the welfare bill. Here’s the OBR’s chart of welfare spending:

The government has already promised to protect child benefit and pension spending – in fact, it actually increased pensioner spending today. So all that’s left is tax credits. If the government is not going to cut them, where’s the £12bn come from?

A bit of clever accounting today got Osborne out of his hole. The Universal Credit, once it comes in in full, will replace tax credits anyway, allowing him to describe his U-Turn as a delay, not a full retreat. But the reality – as the Treasury has admitted privately for some time – is that the Universal Credit will never be wholly implemented. The pilot schemes – one of which, in Hammersmith, I have visited myself – are little more than Potemkin set-ups. Iain Duncan Smith’s Universal Credit will never be rolled out in full. The savings from switching from tax credits to Universal Credit will never materialise.

The £12bn is smaller, too, than it was this time last week. Instead of cutting £12bn from the welfare budget by 2017-8, the government will instead cut £12bn by the end of the parliament – a much smaller task.

That’s not to say that the cuts to departmental spending and welfare will be painless – far from it. Employment Support Allowance – what used to be called incapacity benefit and severe disablement benefit – will be cut down to the level of Jobseekers’ Allowance, while the government will erect further hurdles to claimants. Cuts to departmental spending will mean a further reduction in the numbers of public sector workers.  But it will be some way short of the reductions in welfare spending required to hit Osborne’s deficit reduction timetable.

So, where’s the money coming from? The answer is nowhere. What we'll instead get is five more years of the same: increasing household debt, austerity largely concentrated on the poorest, and yet more borrowing. As the last five years proved, the Conservatives don’t need to close the deficit to be re-elected. In fact, it may be that having the need to “finish the job” as a stick to beat Labour with actually helped the Tories in May. They have neither an economic imperative nor a political one to close the deficit. 

Stephen Bush is editor of the Staggers, the New Statesman’s political blog.