Yield

On Regaining the Triple Crown

CRA laggards and a Downgrade without Macroeconomic Evidence

Cantor and Packer (1996) made a model (the FLS model) predicting sovereign rating changes based on preceding macroeconomic variables (usual- GDP, growth, inflation, deficit, CA, Debt) that proved robust when replicated by other authors in later timeframes and country data, proving that ratings don't give us any new information that everyone already didn't know. Mora (2005) added financial factors (country's spread on Eurobonds and its past default history) to the model and sought to ask "Do ratings change quickly enough when situations change?

∆Rating_i,t = α + βerror_i,t–1 + ε_i,t

Here, the actual change in a country’s rating from mid-year to next is regressed on a one-year lagged error term-which is the change in predicted ratings from the FLS+financial factors model. Beta was proved to be positive (significant at the 1% level).

A Closer Look at S&P’s Mistake

Different Assumptions on how Discretionary Spending Grows

The White House and Treasury criticized the S&P’s downgrade report by claiming it had a $2 Trillion math mistake- but it’s more like a difference in opinion on how to measure projected discretionary spending (DS), here’s my (rough) calculations:

 
*CBO long-term estimates; **Net Federal, State and Local Gov. Debt; Raw Data Source: CBO Budget and Economic Outlook

The Eurozone Stubbornly Forges Ahead

Throwing out the Inflation Targetting Mandate along with the Anti-Bailout Clause

Unlike the Fed, the ECB mandate is restricted to price stability. This means dogged inflation targeting in a post-2008 keynesian world where such behavior has been less than praise-worthy. Though post-2008 crisis, the US accepted CPI inflation rates ranging from -2% to +6%, the ECB, using its chosen inflation statistic- the Harmonized Index of Consumer Prices (HICP), started raising rates step by step immeadiately after the HICP rose past 2% in late 2006. (The HICP high of 4% in mid 2007 was certainly a lagged effect, occurring despite extreme persistence by ECB officials.)

The First Cut is the Deepest

The US's loss of Triple-A and Past Comparisons

In S&P's classroom, the perrenial triple-A students who've never suffered a report indicating a downgrade (in domestic currency OR foreign currency, long-term) were: Austria, France, Germany, Luxembourg, Netherlands, Norway, Switzerland and the UK. And of course, until last friday, the USA. Some commentators and pundits have taken the role of overbearing parents openly lamenting the fiscal future while others remain sanguine of our chubby pupil’s long term prospects (reserve currency status, military might, high GDP and high innovation rate) and critical of the professor’s allegedly meaningless grading criteria.