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S&P threatens to downgrade the entire Euro Zone
Kiron Sarkar
December 6, 2011

Hi there,

S&P partially spoilt my (equity rally) party (especially in respect of my holdings of financials) yesterday by threatening to downgrade 15 Euro Zone countries - they placed them on negative credit watch. The downgrade suggests that there is a 1 in 2 chance of an actual downgrade within 90 days. However, S&P reported that they would release their decision soon after this Friday's EU Summit. S&P added that the long- term ratings on Germany, Belgium, Austria, Luxembourg and Holland aren't likely to fall by more than 1 notch, though France's and other Euro zone countries could fall by 2 notches. Pretty interesting timing, but should strengthen Germany's resolve to push through tough, binding, verifiable measures with automatic sanctions, including ultimately throwing out serial transgressors (Greece). A French downgrade (together with Spain and Italy at least) is on the cards and expected, but the other AAA countries - certainly not.

The news was released after European markets closed - though interestingly, European markets were weak into the close. It did have an impact, though I would argue that such a statement would, in normal circumstances, have a MASSIVE impact - it did not, which just reinforces my bullish stance. For example, the S&P, which was +1.8% up at it's peak, closed +0.7% higher at the close. FTSE futures indicate a -0.8% open, though it's early days.

The Euro clearly weakened on the news and is currently over 1 cent lower against the US$, from it's high yesterday. I intend to retain my Euro/US$ short. One concern is that it really is a crowded trade.

The EFSF is based on the fact that it has guarantees by AAA countries. Given the S&P news, Is this the final nail in it's coffin - seems like it. However, looks like a combination of ECB/IMF (potentially others) will step up to the plate. However, ECB bond buying remains the most potent weapon. I believe they will use it, in spite of the (only) E3.7bn of bond purchases last week.

Germany and France yesterday reached a "comprehensive" agreement (as they put it) in respect of the new fiscal rules to be proposed to the Euro Zone. Essentially, private sector bondholders will not be asked (ex Greece) to bear some losses in any future sovereign debt restructuring. However, with collective action clauses remaining, there is still the likelihood of potential voluntary debt rescheduling.

Mrs Merkel succeeded in persuading France to agree to a revision of the EU treaty (probably just to include the 17 Euro zone members, as the UK will be difficult, to say the least, though she dropped the idea of the European Court of Justice being the final arbiter - the ECJ will merely be required to verify that a "golden rule" (which obliges Euro Zone countries to work to a balanced budget" has been properly introduced in the Constitution of each Euro Zone member. Good luck with Greece.

The treaty amendments are expected to be passed in March next year.

Automatic sanctions will be imposed on countries that beach the fiscal rules (budget deficits to be no more than 3.0% of GDP).

The ESM will be introduced in 2012, rather than 2013 as had previously been the case.

FT Alphaville referred to the agreement as Germany 1, France 0. I would agree. The concession on the ECJ is sensible, especially from a democratic point of view.

Whilst on Greece, the IMF has approved it's E2.2 bn tranche of aid, but warned of a "difficult phase ahead". Mission bloody impossible and you know it, Mrs Lagarde. Will this be the last tranche of aid to Greece, before the inevitable happens - who knows, but Greece in the Euro is an impossibility. Whilst contagion threats remain, quite frankly, Greece being kicked out of the Euro Zone will, in my opinion, be positive.

Mr Berlusconi popped up yesterday - his party threatened to veto tax increases on property. His real game is to get immunity from prosecution. He is likely to continue to be a pain in the a.. Italian 10 year bond yields fell below 6.0% yesterday, though closed slightly above - wonderful news - was sweating there for a bit. S&P threat of a downgrade a bit of a nuisance, but will hold on to my bonds.

Belgium has formed a Government and appointed a PM. Sorry Renaat - apparently, most Belgium's were hoping that they would continue sans government/PM etc;

Other non European news

The Australian Q3 current account deficit came in at A$5.6bn, in line with expectations.

The RBA decided to cut interest rates by 25bps to 4.25% today -as expected.

Asian economies face "greater downside risks" reports the Asian Development Bank ("ADB"). Unfortunately true in my view as their economies are NOT DECOUPLED, and will face (probably greater) economic headwinds if the US/Europe slow down. The ADB also warned of slowing capital inflows - bad news for a capital hungry part of the world;

US November ISM non manufacturing unexpectedly fell to 52, from 52.9 in October - well below the forecast of 53.9. This is virtually the 1st disappointing economic data point from the US recently and quite a surprise;

Mr Evans, head of the Chicago FED calls for more FED action.

Unfortunately, Asian markets are weakening further and gold is being clobbered.

Been instructed to do some Christmas shopping by the boss(my wife) before I return to Ireland. In other words, go to go.

Best
Kiron

 

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