I have written about today's topic a fair few times in the past, but Friday's late announcement by the ratings agency, Fitch, that they were putting the UK's credit rating on a 'negative outlook', cannot be passed up.
The mess that is the sovereign ratings space can be summed up by one incidence. Last year the US lost its AAA credit rating. And, yet, places like the UK, Germany and Singapore have been able to keep hold of theirs. The US prints the world's reserve currency and is the largest and richest economy the world has ever seen. If they do not deserve an AAA rating then nobody does.
Be that as it may, the political ramifications of a downgrade are likely to be a lot worse than any of the economic implications.
Q4 of this year will be the most politically volatile quarter of the entire financial crisis to date. Obviously the American Presidential election is the grandstand event, but other, arguably more important events, are also occurring. Most people in the markets believe that an Obama win is a virtual certainty.
However, the real problem coming out of the US is the 'fiscal cliff' - a combination of huge spending cuts and the expiration of tax cuts - which is expected to reduce US growth by as much as 3% in 2013, if it's allowed to happen. It doesn't have to happen of course, but if Congress is not able to reach an agreement to delay then it will do during Q4.
The fact is that the Congress will be a 'lame duck' by then. Some representatives and senators will have lost their seats and therefore lose bargaining power, and here lies the problem. Idealism held the Congress to ransom in the debt ceiling negotiations last year, triggering talk about the 'fiscal cliff' and a similar thing could happen again. This is the greatest 'tail risk' to markets at the moment.
In Europe, it seems that every weekend we see further anti-austerity protests in the periphery. The volume of these will only increase the longer growth remains a memory and joblessness a way of life. The next elections in Europe are right at the heart of the continent's issues with first Italy and then Germany taking to the polls in the next 12 months.
While there have not been protests in this part of the world (yet), the gathering voices of dissent elsewhere have already toppled governments and there's no reason to suggest the same won't happen again.
Protests here in the UK have been few and far between since the major ones surrounding tuition fees. In fact, the political dangers in the UK emanate from within the ruling coalition government. George Osborne's dedication to keeping the UK's credit rating is a misguided ambition at best and, following a 2012 characterised by sluggish economic performance, his star is already starting to fall.
A move away from 'Plan A' would display good economic awareness, but the politics of doing so remain untenable and would undermine the past two years of policy. That's why it will never happen.
A downgrade of the UK's credit rating would be a terrible day for the men in Westminster, but recent events elsewhere suggest would have very little effect on the fundamentals of UK financing.
France lost its AAA rating in January. The decision marked the near-term turnaround in EURUSD and since we have seen France's borrowing costs fall by around a third. Likewise the cost of ensuring France's debt against default has fallen 45%. Sterling may take a bit of a hit as a result, but if the government is so in favour of a 'March of the Makers' then a devalued pound would help exporters.
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