S&P warns Europe, sends markets reeling

Early in the US session on Monday, news leaked that Standard & Poor’s took a surprise decision and put 15 eurozone nations on credit watch rating negative, threatening them with a credit rating downgrade. The rating agencies threat included AAA-rated Germany and France, with the latter warned that its prized rating could be cut by two notches as opposed to its other triple-A rated euro bloc peers, who risked “only” losing one notch.

A downgrade of the eurozone could be catastrophic- Emman Xuereb

The timing of this “bombshell” left much to be desired, but S&P acknowledged this and pledged to reach a conclusion as soon as possible after the upcoming European Union summit. The agency said ratings for Austria, Belgium, Finland, Germany, the Netherlands and Luxembourg could be lowered by one notch, and by up to two notches for the remaining nine placed under review, including currently AAA-rated France.

Cyprus and Greece were the two euro nations not put under review on Monday. Cyprus was already on downgrade watch and Greece already has a ‘junk’ CC-rating. Risk sentiment was sent reeling following the shock warning, after opening the week on a positive note with news of an austerity plan in Italy, and after French President Nicolas Sarkozy and German Chancellor Angela Merkel concluded talks in Paris in which they reached a “master plan” to solve the eurozone debt crisis.

Undoubtedly, this latest action by one of the major rating agencies invited strong criticism by European officials. Christian Noyer, the current head of the Bank of France and member of the European Central Bank’s governing council said the actions of rating agencies are themselves worsening the eurozone debt crisis, and added their methods for assessing governments’ creditworthiness had become increasingly political. In a polemic tone, he told a conference on corporate finance in Paris that “the agencies were one of the motors of the crisis in 2008. Are they becoming a motor in the current crisis?”

Eurogroup president Jean Claude Juncker said he was “not unsettled by this”, but added that he was “astonished, after significant efforts in recent days to overcome the crisis.” President Sarkozy and Chancellor Merkel, in response to S&P’s action, said they were united in their determination, along with their European partners, to “take all measures to secure stability in the euro zone”.

An unprecedented mass downgrade of eurozone nations could have catastrophic implications on the single currency. Mostly it would make the task of restoring confidence in European markets more arduous than ever before.

The week started off on a different tone altogether. Risk appetite was supported by rising expectations that policymakers will by end of the week agree on new rules for enabling tighter fiscal integration which in turn may pave the way for a more aggressive intervention by the ECB. A €30 billion austerity package was presented by Italian Prime Minister Mario Monti and approved by the Cabinet, also lifting risk sentiment. Global markets were on the rise, and higher-yielding currencies were supported across the board.

A conference in which Ms Merkel and Mr Sarkozy announced that they had agreed on a master plan to strengthen the eurozone boosted sentiment further. Proposals included penalties for governments that fail to keep their deficits under control and an earlier launch of the European Stability Mechanism, the permanent rescue funding programme which is to succeed the temporary European Financial Stability Facility by mid-2013.

The euro rose to 1.3487 against the US dollar shortly after the Franco-German news conference, more than one hundred points above Friday’s low. The Australian dollar also edged higher on Monday, rising to above 1.0300 against the buck, to 1.0305. But, S&P’s announcement shifted flows back in favour of “safe-haven” assets and the US dollar and the Japanese yen recovered, putting riskier currencies such as the euro and the Aussie under pressure.

Risk appetite came under more pressure on Tuesday after the Reserve Bank of Australia cut its interest rates by 25 basis points to 4.25 per cent, leaving the door open for further cuts. The RBA cited European woes and moderating global growth, especially in China, as the factors behind its decision. EUR/USD fell to 1.3333 by the time of writing on Tuesday while AUD/USD dipped to 1.0156. Forex investors appeared to be reluctant on selling the euro more aggressively, ahead of an European Central Bank meeting scheduled for today, and as traders hope on a summit agreement tomorrow. The ECB is widely expected to cut its key interest rates by another 25 basis points.

Upcoming FX key events:
Today: UK BoE Monetary Policy Decision & EZ ECB Interest Rate Decision and News Conference.
Tomorrow: German CPI, UK PPI & US Preliminary Michigan Confidence.

FX technical key points:
EUR/USD is bearish, target 1.3150, key reversal point 1.4100.
EUR/GBP is neutral.
USD/JPY is neutral.
GBP/USD is bearish, target 1.5125, key reversal point 1.6170.
USD/CHF is neutral.
AUD/USD is bearish, target 0.9600, key reversal point 1.0745.
NZD/USD is bearish, target 0.7300, key reversal point 0.8239.

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Mr Xuereb is a trader at RTFX Ltd.