Monday, 16 January 2012

Downgrade. Euro.


One should always be prepared for a hefty surprise in these markets. Suddenly I find myself agreeing with S&P! In the explanation for the downgrade of France the following gem is hidden:

“The outcomes from the EU summit on Dec. 9, 2011, and subsequent statements from policymakers lead us to believe that the agreement reached has not produced a breakthrough of sufficient size and scope to fully address the eurozone's financial problems. (...)  We also believe that the agreement is predicated on only a partial recognition of the source of the crisis: that the current financial turmoil stems primarily from fiscal profligacy at the periphery of the eurozone. In our view, however, the financial problems facing the eurozone are as much a consequence of rising external imbalances and divergences in competitiveness between the eurozone's core and the so-called "periphery." As such, we believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating, as domestic demand falls in line with consumers' rising concerns about job security and disposable incomes, eroding national tax revenues.” (My emphasis).
Also very useful to read how S&P are justifying their broad sweep.Somebody have been reading up on their Kindleberger and the history of the crisis in 1929-32.

The only question is: what would S&P have done if France (and Germany) had introduced reforms and tax changes to spur domestic demand and had offered long-term loan programs to Greece and Portugal to help productivity development. Or if Italy had embarked on a long, slow reform program to set free the country from decades of bad management of the laws?

Probably they would have downgraded France and Italy anyway, so in that respect the above quote is just a proof how much of a political institution SP really is. We now wait for the next chapter: The downgrade of Germany. Ultimately it is Germany that has forced a wrong solution upon the rest of the euro 17.

Will it mean anything for France and the 8 other downgraded euro-nations? Too early to tell. But for sure a lot had been priced in already.

More interesting, is this a game-changer? My feeling is that it is not. After all, I cannot remember a rating change that was forward-looking and indicative of any changes that were not already visible to everybody else. But we will be able to see it in the risk appetite in the coming days.


The euro has fortunately weakened further as a result of the ratings. Good for Europe! However, Colleague Frank points out that the number of short positions betting against the euro is at a historical maximum. But I found a piece on Bloomberg that left me puzzled. Who had understood that the reason for the surprising strength of the euro was that it was propped up by the AUD. Silly me! I thought it was the belated reactions on the part of ECB that had caused the euro to remain stronger than the other main currencies. Never too late to learn something new...

Reuters carry an interesting story – and they appear very keen on telling us that it is well-researched: Hedge funds have apparently bought sufficiently many Greek bonds to actually force a default. That would immediately release the payments of CDS according to ISDA rules.

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