“Buy, buy says the sign in the shop window; Why, why says the junk in the yard.”
- Paul McCartney
Greece and Cyprus were the only two nations from the embattled currency union to avoid the threat of downgrade last night, the rationale being that Cyprus is already on credit watch negative and Greece is already classified as ‘junk’. The synopsis for the rest of the Eurozone, whilst the timing has been brought into question, could not in my mind have been more apt.
S&P warned last night that 15 of the EU17 countries were facing credit downgrades. The rationale behind the threat is that rising ‘systemic stress’ due to an approaching recession, a dysfunctional political process and the onset of a banking credit crunch justify the stance. (The AAA rated countries of Germany, France, Austria, Finland, the Netherlands and Luxembourg are likely to see just a single notch downgrade with the rest likely more.)
Closing the barn door after the horse has bolted?
After yesterday’s joint statement from Merkel and Sarkozy, the markets had breathed a small sigh of relief, European equities rallied and for the most part the EUR faired reasonably well in a moderately improved risk backdrop. However, on further reflection of the headlines the statement from Merkel and Sarkozy seemed to centre around measures to prevent internal fiscal imprudence happening again by amending the existing treaty and imposing debt limits (which are not possible under the current treaty). The statement that the “aim is to bring the ESM forward to 2012” should have been supportive to Eurozone bonds, but arguably countered by the fact that there seems to be no further progress on the leverage of the European Financial Stability Facility to an amount which may convince the market that it has enough firepower to prevent periods of deleveraging turning into further sovereign crises.
Sovereigns sans frontier?
Ultimately, the issue remains. We find out more detail about the Merkel, Sarkozy agreement from the letter to EU President Van Rompuy tomorrow, however I do feel that the Eurozone crisis issue has now stepped up a level in importance. A resolution is no longer a requirement, but a necessity. In their summary of the issues within the Eurozone S&P centred on their concerns for bank funding, in particular for France where the value of their external debt is greater than the value of France’s GDP. In the next three months the French State has EUR126 billion of maturing debt adding to the concerns and suggesting that the already highly debt burdened Sovereign could not afford to bailout its banks, without severe repercussions. Banque De France governor Christian Noyer said this morning that the “French Economy’s only problem is lack of confidence.”
“We must prevent the euro from dividing the European people” – Mario Monti
In Italy yesterday the testimony of technocrat Prime Minister and Finance Minister Mario Monti appeared well received by the markets with the yield on 10-year Italian debt falling to below 6 percent, from a high of 7.48 percent just a few days ago. The biggest issue as far as I am concerned however is the timeframe not only over which measures will take to work in lowering the deficit, but also the time it will take to convince markets that the measures are indeed working to do so. In the short term growth may be the biggest sacrifice. Monti suggested yesterday that “Economic growth will likely take longer”.
In Australia the Reserve Bank of Australia cut the benchmark interest rate by 25bps as was broadly expected (though expectations had been pared back over the last 24 hours as a result of the suggestion from a well respected commentator who cast doubt over the move) taking the rate to 4.25 percent. With a reduced, though still significant, yield differential and a continued disparate and, in many cases, declining global economic backdrop, I would continue to expect the AUD to underperform, whilst the volatility will make the downside progress more difficult, AUD for me remains significantly overvalued.
Today we get an interest rate decision from the Bank of Canada, though it is likely that the current global economic uncertainty is enough to postpone the tightening that the central bank mooted over recent months.
Focus of markets today is likely to be on further rhetoric, or clarification of intentions from Eurozone officials, Eurozone peripheral bond yields and equity markets, where sentiment has held in fairly well despite the S&P threats overnight.
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