S&P cut Australia credit rating outlook to negative

There seems a good chance Australia will lose its AAA rating held by S&P after the two year review period.

Sydney
Source: Bloomberg

But we shouldn’t be concerned…this is semantics at best, although the Australian banks may see an impact in the wholesale funding markets. The surprise is perhaps the timing. The recent commentary from S&P detailing that they ‘could lower the rating if parliamentary gridlock continues and Australia budgetary performance doesn’t not improve broadly as we expected a year ago’ has effectively just been made official. This seems a function of S&P saying ’why wait?’

If it occurs, S&P will presumable lower the rating one notch to AA+. The obvious concern is with such a high level of foreign ownership of Aussie debt (60.4% as of March 2016) that we may see forced sellers, which could cause sizeable capital outflows of Australia. Not to mention a move higher in bond yields, which will negatively affect the Australian Treasury in their ongoing funding task. This is not the situation and in the case of the US, who lost their AAA status in August 2011, we actually saw yields subsequently falling. This was not the same in the equity market where the S&P 500 lost 6.7% on the day of the actual downgrade, with the US banking sector losing 9.3%. In the case of France (22 February 2013) and the UK (13 January 2012) bond yields fell, but equities actually rallied modestly.

If we look at the market’s reaction today, we have seen absolutely no move in the front-end of the Aussie fixed income curve, and while the AUD/USD initially fell 0.8%, it has found better buying. Banks are where the stress can be seen, and traders and investors are clearly stating that funding costs are likely to go up as a consequence of any potential rating change. This could naturally have an impact on margins, although the banks seem fairly well prepared for this and have been active in the funding markets in the last 12 months.

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