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Eurozone crisis live: S&P cuts French credit rating on night of downgrades – 13 January 2020
1.16am: It’s a shame to wrap things up when there’s still a lively debate in the readers comments, but I’m afraid we’re out of news for the night.
Here’s an end-of-play summary:
The European financial crisis has moved into a new phase after Standard & Poor’s cut the credit rating on nine eurozone countries, and Greece’s debt talks collapsed without agreement.
The long-awaited loss of France’s AAA was the most high-profile move from S&P, which also cut Austria’s triple-A rating and pushed Portugal and Cyprus into junk status. S&P’s move, which was rumoured for most of the afternoon, is a major embarrassment for Nicolas Sarkozy, and will also undermine Europe’s bailout fund. There is a one-in-three chance of France being downgraded again by the end of 2020.
S&P criticised European leaders for not making more progress, and criticised the focus on austerity. Fiscal cutbacks alone, it said, will not solve Europe’s problems and could make the crisis even worse.
The nine countries downgraded were France, Austria, Malta, Slovena, the Slovak Republic, Spain, Italy, Portugal and Cyprus (details here).
Meanwhile in Greece, the body representing private creditors admitted that it was struggling to reach a deal over the Greek debt reduction programme. The news that talks had broken up without agreement was seen as very serious by several analysts, as it makes a disorderly default more likely.
The double-dose of bad news sent shares falling and pushed the euro to a 16-month low against the dollar.
There was little good news – although an auction of Italian bonds did go pretty well.
We’ll be back on Monday, for another installment of euro crisis. Thanks for your time and contributions. Goodnight!
12.57am: The downgrades are dominating tomorrow’s newspapers.
The Guardian’s front page splash about the crisis is here.
12.29am: A couple of analysts have given their views on S&P’s downgrades (so we’re not the only people still focusing on Important Issues on a Friday night).
With thanks to Reuters:
Fabrice Seiman of Lutetia Capital, in Paris:
S&P is absolutely right. France is paying the price of 30 years of irresponsibility in public finances.
French politicians on the right and on the left fell short of the job by not
taking measures to reduce spending.
Bill O’Grady of Confluence Investment Management, in St Louis:
If France had been downgraded more than one level it would have precipitated a crisis. This is not good but it was anticipated, baked in.
12.10am: Here’s a full list of tonight’s ratings actions from S&P:
France: Downgraded by one notch, from AAA to AA+. Negative Outlook.
Austria: Downgraded by one notch, from AAA to AA+. Negative Outlook.
Malta: Downgraded by one notch, from A to A-. Negative Outlook.
Slovenia: Downgraded by one notch, from AA- to A+. Negative Outlook
Slovak Republic: Downgraded by one notch, from A+ to A. Stable Outlook
Cyprus: Downgraded by two notches, from BBB to BB+. Negative Outlook
Italy: Downgraded by two notches, from A to BBB+. Negative Outlook
Portugal: Downgraded by two notches, from BBB- to BB. Negative Outlook
Spain: Downgraded by two notches, from AA- to A. Negative Outlook.
Belgium: Unchanged at AA. Negative Outlook.
Finland: Unchanged at AAA. Negative Outlook
Ireland: Unchanged at BBB+. Negative Outlook
Luxembourg: Unchanged at AAA. Negative Outlook
The Netherlands: Unchanged at AAA. Negative Outlook
Germany: Unchanged at AAA. Stable Outlook
11.50pm: So what now for the European Financial Stability Facility?
The word from S&P is that it will “will publish our updated credit view in the coming days” on Europe’s bailout mechanism. A downgrade feels almost certain (as Mohamed El-Erian hinted at 10.44pm)
UPDATE: John Chambers of S&P is explaining now that the EFSF would need “further commitments from its guarantors” to retain its AAA status. Hmm – is Germany really about to pledge even more cash?
Analysts have already calculated that a one-notch downgrade to the French AAA would rob the EFSF of at least 20% of its firepower, by driving up its own borrowing costs.
As explained here, the EFSF is only as strong as its backers. Now Germany is the only major European economy with a AAA rating, so the EFSF is by definition a riskier bet.
11.22pm: Standard & Poor’s has released a full statement explaining tonight’s downgrades. You can see it here.
I’ve pulled out one important section, in which S&P explains how European leaders are getting this crisis badly wrong.
The outcomes from the EU summit on Dec. 9, 2020, 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.
In our opinion, the political agreement does not supply sufficient additional resources or operational flexibility to bolster European rescue operations, or extend enough support for those eurozone sovereigns subjected to heightened market pressures.
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.
In other words — it is a serious mistake to make Greece, Ireland and Portugal enforce tough austerity packages that destroy growth.
Fixing the imbalances at the heart of Europe is damn difficult, though. Even if you accept that richer nations (Germany) need to accept the transfer of wealth within the eurozone (by debt reduction, eurobonds, or QE by the ECB), that won’t deliver the radical changes needed across European industry.
Economic data in 2020 has already shown that Germany and France have had a relatively good crisis, while Spain and Italy have suffered large drops in output. That suggests the problem is actually getting worse.
Mohamed El-Erian, chief executive of Pimco, has said America’s valued AAA credit rating is ‘extremely vulnerable’ Photograph: Bloomberg/Bloomberg via Getty Images
10.44pm: Mohamed El-Erian, head of bond trading giant Pimco, is discussing the S&P downgrade on Newsnight now.
He has warned that the decision to downgrade France will have serious long-term consequences, because:
It places a wedge in the centre of the eurozone, making a solution much more difficult.
He added that it will also make it much harder for European countries to help each other – an indication that the European Financial Stability Facility (the current bailout fund) will probably soon be downgraded too.
10.26pm: The decision to downgrade Portugal by two notches (from BBB- to BB) means that it is now classed as a Junk-grade country by S&P.
Ditto Cyprus, which was cut by two notches from BBB to BB+.
This means that there are now three eurozone countries rated as Junk status by S&P — effectively, a speculative bet — up from just one (Greece) before today.
In another blow, the number of AAA-rated nations is down to four, from six. With France and Austria both losing their triple-A ratings, that leaves Germany, Finland, the Netherlands and Luxumberg.
10.17pm: As well as being downgraded tonight, France has been warned that it faces “at least a one-in-three” chance of being downgraded again this year, or in 2020.
S&P explained that another downgrade could come if there was “a significant increase in contingent liabilities” or if external conditions worsen.
By contingent liabilities, S&P is referring to possible future losses within the French banking sector.
10.02pm: Heads-up politicians — S&P has also warned that austerity alone will not fix Europe’s financial problems.
In its statement justifying tonight’s downgrades, the rating agency said that fiscal austerity alone “risks becoming self-defeating” and furthermore “does not address the full spectrum of the financial turmoil”.
That warning must be directed towards the International Monetary Fund as well as Europe’s corridors of power.
9.50pm: S&P is justifying its decision now – saying that European leaders have only taken “insufficient policy measures” to address systemic stresses in the financial system.
(just off to help update the paper for the next edition – very multiplatform)
9.46pm: OK, a total of Nine Countries have been downgraded tonight.
Austria, France, Malta, Slovakia and Slovenia have all been cut by one-notch
Cyprus, Italy, Portugal and Spain have been cut by two notches.
Germany, the Netherlands, Belgium, Estonia, Finland, Ireland and Luxembourg have all seen their ratings affirmed.
9.43pm: Now Austria – and it is also cut by one notch, like France, to AA+.
Germany, though, has seen its AAA rating maintained along with a Stable outlook.
9.41pm: Spain has also just been cut by S&P — by two notches to A (from AA-).
And Finland keeps its AAA rating — but sees its outlook cut to negative.
9.36pm: The first results are in! As expected, France has been downgraded by one-notch to AA+.
Importantly, S&P has also left the country with a negative outlook – suggesting further cuts are possible.
9.33pm: And here’s some rather blunt comments from investor Marc Faber — who reckons that most countries are ridiculously highly rated.
Faber told CNBC tonight that:
Most of the European countries should be rated triple-C and the U.S. “should not be a “triple-A-minus but a triple-B or junk bond when you really analyze the unfunded liabilities that will come due in future,”
9.04pm: While we’re waiting for S&P to drop, here’s some comments from Nick Clegg on the issue from earlier this evening:
This development, if confirmed, just dramatically underlines the urgency of a
comprehensive approach to dealing with the imbalances and problems which we
have in Europe and in the eurozone.
The deputy prime minister argued that the solution is a new push for growth and productivity:
We don’t need to reach for new treaties or agreements or policies. We
know what we need to do. We need to complete the single market and create a
dynamic and greater growth in the EU to help us out of these problems.
9.03pm: They’ve rung the Wall Street bell – where the Dow Jones industrial average finighed 48 points lower at 12422 (so down 0.4%, mirroring London’s fall).
Now over to you, S&P.
8.57pm: Here’s another vote of no-confidence in the eurozone. Currency speculators are ‘shorting’ the euro at a record level, according to data from the US Commodity Futures Trading Commission.
The number of Euro short contracts sold by CFTC jumped to 155,195 in the last week. That’s up from 127,900 contracts a week ago, which was the equivalent of €16bn of money bet on the euro dropping in value.
8.30pm: Tonight’s sovereign credit rating downgrades will probably be followed by a rash of downgrades for individual banks.
Sony Kapoor, of Brussels-based think tank Re-Define, has dubbed this tha “sovereign-bank dance of death”.
Here’s his full quote tonight:
S&P had given EU leaders fair warning but they have wasted the month they have had to change course and come up with a credible crisis resolution strategy.
This action will probably lead to a series of bank downgrades next. The sovereign-bank dance of death continues.
Sony also tweeted:
@SonyKapoor I wd not get too emotional abt downgrades, plenty more where these r coming from!
President Nicolas Sarkozy speaking at the Elysée Palace in Paris today. Photograph: Charles Platiau/AP
8.17pm: Losing France’s AAA rating is Nicolas Sarkozy’s worst election fear, according to my colleague Angelique Chrisafis in Paris.
She writes that:
With less than 100 days until the first round of the French presidential race, the credit-rating downgrade in Paris will seriously complicate Nicolas Sarkozy’s already difficult bid for re-election.
“If France loses its AAA, I’m dead,” Sarkozy told aides in October, according to Le Canard Enchaîné. The president has staked his re-election on convincing France that he is the only person with the guts, strength and character to save it from economic doom. The rating cut will seriously dent his image as the Caped Crusader of the financial world.
8.01pm: Italy is now admitting that it is caught up in the S&P downgrade net.
The ANSA news agency reports that the Italian government has been tipped off by Standard & Poor’s (as is official practice for rating agencies). Earlier, EU officials had said Italy would be cut by two levels to BBB+.
7.49pm: Here’s a few more expert comments on the downgrades:
Charles St-Arnaud of Nomura:
The French downgrade will be more political than economic. Now that France has lost its AAA status, it will give even more power to the German chancellor in negotiations.
Samarjit Shankar of Bank of New York Mellon
We’re starting to see big portfolio managers isolate the euro zone altogether and look elsewhere. They’ve by now discounted the fact that Europe is not going to get its act together.
David Woo of Bank of America-Merrill Lynch
The good news is that since the start of the year, U.S. data has been reasonably strong. If that continues, it could make recession in Europe more shallow.
Scott Sherman of Credit Suisse:
Over the long term I’m not really sure that it makes that much of a difference but when people see these negative headlines they’ll move into the safety of US Treasuries.
Our first round-up of reaction is here.
7.27pm: Jean-Marie Le Guen, a senior Socialist party MP, has given Nicolas Sarkozy a taste of the abuse he will suffer when the French credit rating is officially cut.
Le Guen declared that:
This is first terrible news for France, our country will pay very heavily the consequences of this decision
France is particularly targeted because it has increased its debt by a reckless fiscal laxity that we have repeatedly denounced.
Hat-tip to Business Insider, who have also deliciously billed the downgrade as “Bad News For Sarkozy, But Good News For Somebody Else”.
7.12pm: French finance minister François Baroin also declared that:
Most eurozone countries have been notified of a downgrade by S&P.
What might most mean? Of the 17 members of the eurozone, 15 were warned by S&P last month that they could be downgraded. We’ve heard strong denials from Germany, Finland, the Netherlands and – in the last few minutes – Ireland.
That leaves ten on the table — Austria, Belgium, Luxembourg,Estonia, Italy, Malta, Portugal, Slovakia, Slovenia and Spain.
And France – whose finance minister has just confirmed the downgrade.
French Finance Minister Francois Baroin late last year. Photograph: Remy De La Mauviniere/AP
7.03pm: Official confirmation from France that its credit rating has been downgraded.
Finance minister François Baroin has just announced that the country has been warned that it will be downgraded by one notch.
Baroin also declared that the downgrade is “not a catastrophe”, as AA+ is “still a good grade”.
He added that France will not bring in a new austerity plan, but that the governent will propose “strong reforms”.
6.48pm: This feels like a good moment to recap.
• Standard & Poor’s is expected to downgrade several Eurozone members tonight. It’s not clear when the announcement will come — 9.30pm GMT is one possibility.
• From rumours sweeping the European markets, it appears likely that France, Austria, Italy and Slovenia are among those who could be cut. Italy is rumoured to be facing a two-notch downgrade, while France could be cut by one notch, from AAA to AA+.
• Germany, the Netherlands, and Finland are all thought to have avoided a downgrade. One German politician argues that the UK ought to be downgraded too.
• Nicolas Sarkozy is expected to address the French people tonight about the downgrade.
Must remember that there is another significant development this afternoon — talks in Greece over its debt reduction programme have collapsed, with the two sides unable to reach a deal.
6.24pm: A senior German politician has claimed tonight that Britain’s AAA rating should be cut in line with the expected French downgrade.
Michael Fuchs, deputy leader of Chancellor Angela Merkel’s Christian Democrats party in the German parliament, described S&P’s plans as ‘out of order’ and accused the agency of ‘party politics’.
Fuchs pointed out that Britain’s national debt is larger than France’s – so how can the Brits keep a AAA?
Here’s the full quotes (via Reuters):
Standard and Poor’s must stop playing politics. why doesn’t it act on the highly indebted United States or highly indebted Britain?”
If the agency downgrades France, it should also downgrade Britain in order to be consistant.
European solidarity alive and well. Of course, Britain’s position is somewhat different as it’s not in the eurozone. And the Bank of England’s quantitative easing programme has helped to maintain demand for Uk gilts.
6.05pm: The latest rumour on Italy is that it is being cut by two notches by S&P, from A to BBB+ .
5.43pm: There’s a good piece on the Wall Street Journal tonight, explaining the four things to watch out when/if S&P’s announcement is released.
• Who is and isn’t downgraded will be crucial.
• The outlooks attached to the ratings will set the tone for trading.
• While much of the focus has been on France, the country most at risk from a downgrade is Italy
• While the S&P action will remove some uncertainty, it is only the first agency to move.
* Les Echos are reporting that the news might not come until 9.30pm GMT
5.34pm: Dow Jones is reporting tonight that it has “confirmed” that France has been downgraded by one notch.
That’s via a French government official, rather than S&P itself. There’s bit more details here.
If that’s true, then a one-notch downgrade is arguably better than France’s worst fears.
There are also rumours coming out of Helsinki tonight that Finland has not been downgraded by S&P.
5.19pm: On a lighter note, the threat of a downgrade is sparking some witty banter on Twitter.
@SimonNRicketts: Latest. AA Gill and AA Milne also downgraded to just plain ‘A’.
And from another colleague Esther Addley
@estheraddley: Meanwhile, pity the aardvark #rubbishdowngradejokes
Others mentioned in dispatches:
@Emperor_of_Elba: Alcoholics Anonymous downgraded to plain ‘Alcoholics’
@RobCoUk: . and the AA has downgraded to the RAC
From columnist to reporter, perhaps.
Who can do better, then.
5.07pm: European stock markets have closed for the day. While most indexes finished lower, it’s worth noting that shares recovered from their lowest points.
The S&P downgrade threat did not spark a panic.
The FTSE 100 finished 25 points lower at 5636, down 0.46%.
The German DAX fell 36 points to 6143, down 0.58%.
The French CAC fell just 3.5 points to 3196, down 0.1%.
Italy’s FTSE MIB fell 181 points to 15011, down 1.2%.
The euro has clawed back some ground too (to $£1.267, down around 1.5 cents for the day).
Against the pound, the euro has fallen around one pence to to 82.8p.
4.57pm: Nicolas Sarkozy is reportedly planning to address the French people on national TV this evening.
The downgrade (should it happen) doesn’t come at a great time for Sarko, less than four months before the French presidential election.
The latst polling has shown Sarkozy lagging behind Socialist candidate Francois Hollande, and only narrowly ahead of the National Front candidate, Marine Le Pen.
4.25pm: Elsewhere in the Eurozone crisis, talks between Greece and its private sector creditors appear to be on the brink of collapse tonight.
In a very worrying development, the negotiations have been suspended after the two sides were unable to make progress on Greece’s debt reduction.
The IIF, which represents the investors who hold Greek debt, released this statement this afternoon:
Discussions with Greece and the official sector are paused for reflection on the benefits of a voluntary approach.
We very much hope, however, that Greece, with the support of the Euro Area, will be in a position to re-engage constructively with the private sector with a view to finalizing a mutually acceptable agreement on a voluntary debt exchange.
The two sides have been trying to hammer out a deal under which private investors take a haircut of up to 50% on their Greece’s sovereign bonds, along with up to €100bn of debt forgiveness.
If that deal cannot be agreed, then Greece will not get its next aid tranche (Angela Merkel made that very clear on Monday).
Without that money, Greece cannot repay €14bn of debt which mature in March.
The chances of Greece defaulting, in a disorderly manner, have just risen significantly.
Gary Jenkins of Swordfish Research reckons that we’ve just seen the ‘nuclear option’ deployed in Greece. A disorderly default could leave the European Central Bank facing huge losses:
In a default scenario who is holding bonds becomes largely irrelevant, its what you are holding that matters.
4.15pm: A French government spokeswoman just appeared on BFM TV to discuss the downgrade rumours. She replied that:
France remains a safe investment, and can repay its debt.
On previous occasions, French government sources have been quick to deny rumours that a downgrade was immiment. Not this time.
4.12pm: Here’s some analyst reaction to the impending downgrades.
Gary Jenkins of Swordfish Research:
The shock would be if the agencies did not downgrade after all the talk and warnings of the last couple of months.
Mind, the rumours are suggesting that Germany stays AAA, but France gets downgraded, and remember all ratings are a relative view of default probability…so relatively not nice for France but not exactly a shock if the rumours are true.
Indeed I would say that if Germany stays AAA that is about the best outcome possible from this starting point.
Michael Hewson of CMC Markets:
Major concern surrounds France especially in relation to its contribution to the EFSF, the EU bailout fund, where a downgrade to the fund’s second biggest contributor would effectively hole the fund below the proverbial water line.
David Song, currency analyst at DailyFX:
Standard and Poor’s is expected to downgrade France, Spain, Italy, Belgium, Portugal and Austria later today. This credit event could spark a flight to safety as the heightening risk for contagion bears down on investor confidence.
As the ongoing turmoil in the financial system drags on the real economy, the European Central Bank may have little choice but to expand monetary policy further. Additionally, we may see the Governing Council continue to ramp up its balance sheet in an effort to shore up the banking system.
Richard Driver, analyst for Caxton FX:
We all knew S&P was going to get its axe out but it has come a little sooner than expected and it only reinforces our bearish view on the single currency.
It sounds like Germany’s AAA-rating will be left alone, which is a relief, but this French downgrade is a major development if it’s confirmed – Sarkozy will be furious.
The big question is by how many notches France’s rating is to be cut, one is manageable but two will really test the euro’s resolve.
3.54pm: Bloomberg is reporting that the S&P announcement will come at 8pm GMT.
3.49pm: A French downgrade would have serious consequences for Europe’s bailout rescue mechanism, the European Financial Stability Facility.
The EFSF is the vehicle that borrows the money for Greece, Ireland and Portugal — the three countries that have signed up for financial rescue packages with the International Monetary Fund.
Klaus Regling, chief executive of the EFSF. Photograph: Peter Parks/AFP/Getty Images
At present, the EFSF (run by Klaus Regling, pictured) has a AAA rating, reflecting the credit-worthiness of the six countries who fund it — Germany, France, Holland, Austria, Finland, and Luxembourg.
Most of the funding comes from Europe’s two largest economies, so if France is downgraded then it is inconceivable that the EFSF would not follow. S&P hinted as much last October, when it stated that:
In general, we expect the outlook on EFSF’s issuer credit to reflect the outlook on the sovereign rating of its weakest ‘AAA’ guarantors.
Christopher Adams, the FT’s Markets Editor, made this point on Twitter:
@ChrisAdamsMKTS: France & Austria to be cut to AA+ leaving Germany as only large triple-A country underwriting EFSF
And if the EFSF loses its AAA, then its own cost of borrowing would probably increase.
3.28pm: Stock markets are in retreat this afternoon, as the Eurocrisis moves centre-stage again.
On Wall Street, the Dow Jones has dropped by 136 points to 12335, a fall of 1%.
In the City, the FTSE 100 is now down 61 points at 5600, a fall of 1%.
The euro has also plumbed new depths, hitting a low of $1.2623 against the dollar this afternoon.
3.25pm: French television is now reporting that France is one of the countries that will be downgraded by S&P tonight.
3.23pm: City analysts reckon that the S&P announcement may not come until late tonight.
The rumours of a downgrade was greeted with resignation by one economist, who had been hoping to get home early to start the weekend.
No chance of that. Often, these downgrades come after 9pm GMT (once Wall Street has closed).
3.11pm: Until now, the eurozone had been enjoying a decent week. Bond auctions have gone well, world leaders have held encouraging talks, and the stock markets have been calm.
Perhaps that’s why Standard & Poor’s have decided to act today — better now than when the crisis is already raging?
Superstitious readers may note that today is Friday 13. A pure coincidence, of course. except that when S&P downgraded Spain last autumn, the announcement came on Friday 13 October. #spooky
2.59pm: The threat of an S&P downgrade has been hovering over the eurozone for more than a month.
Six nations were warned that they faced a one-notch downgrade — Austria, Belgium, Finland, Germany, Netherlands and Luxembourg.
Nine more were told they could suffer a two-notch downgrade: Estonia, France, Ireland, Italy, Malta, Portugal, Slovakia, Slovenia and Spain.
Senior sources in the Netherlands are spinning that they are not on tonight’s list. So they, and Germany, would appear to be safe. That still leaves 13 potential victims.
2.44pm: Afternoon all. The report that S&P is going to downgrade several eurozone countries tonight has been sweeping the City this afternoon, driving share prices down and bond yields up.
So who might be downgraded? Rumours are absolutely rife — the latest idea, via @zerohedge is that five countries will be cut: France, Spain, Italy, Belgium and Portugal.
As we mentioned at 2.09pm, the suspicion is that Germany will not be downgraded. Beyond that, it’s pretty much open season.
2.31pm: European stock markets are now falling, after the Dow Jones opened 90 points lower at 12377, a 0.7% decline. Germany’s Dax is 42 points, or 0.7%, lower, while France’s CAC has slipped 3.8 points. The FTSE in London is trading nearly 50 points lower at 5613, a 0.87% fall.
That’s all from me – Graeme Wearden is taking over the blog, for what could be a dramatic afternoon.
2.15pm: In Greece, government officials and creditor banks have adjourned without reaching a deal on debt restructuring. They expect to resume talks next week. Athens desperately needs a bond swap to stave off a debt default, with a large tranche of bonds coming due in March.
Greek finance minister Evangelos Venizelos said after meeting with IFF chief Charles Dallara, who represents banks and insurers, for a second day:
We will most likely resume talks next Wednesday. We must process more issues.
Dallara left the meeting without making a statement.
2.09pm: Loads of downgrade rumours on Twitter again today. sparked by Reuters reporting that Standard & Poor’s is set to downgrade several eurozone countries today, but Germany is not amongst them, citing senior eurozone sources. Well it is Friday the 13th.
Eurozone source says Germany will not be downgraded. So France likely will be
1.51pm: The FTSE turned negative after the JPMorgan figures, which showed fourth-quarter profits down from a year ago. Britain’s bluechip shares are now trading nearly 20 points lower at 5643, a 0.34% fall.
12.36pm: Breaking news from Greece where our correspondent Helena Smith says talks between government officials and the country’s private sector creditors have just resumed for a second day.
Is this finally the countdown to the debt deal market forces are waiting for?
Senior finance ministry officials say “the signs are hopeful.” “But,” one insider has just warned, “don’t expect the talks to be over today. This is going to go on for several days. We should have an outline of the agreement by the end of next week but that won’t be the end, it will only be the beginning.
“After that the Greek side has to make the official public offer probably in early February. We all very aware that the whole world is holding their breath, that without this bond swap there can be no further aid, that bankrupcty beckons.”
Charles Dallara, who heads the Washington-based International Institute of Finance, representing the banks, insurers, hedge and pension funds that hold Greek government debt, is expected to be locked in talks in the office of Prime Minister Lucas Papademos for at least the next two hours, I am told.
Papademos, a world-renowned macro-economist, has reportedly been burning the candles at both ends: leaving his desk at 3am and returning a mere four hours later in preparation for the talks. The nervousness in hard to miss. Speak to any Greek official about the efforts to pull off the euro-area’s first large-scale restructuring and the reaction is anything but sanguine.
Even finance minister Evangelos Venizelos, who has won widepread plaudits for his super-cool handling of Greece’s worst economic crisis since the second war, is said to be “stressed out ” by negotiations that have been described, variously, a “difficult,” “intense” and “extraordinarily complex.” An insider said: “We really are at a critical point. Everything rests on the PSI and whether they [private creditors] agree to accept 50% losses on the nominal value of their holdings.”
Fierce horse-trading cannot be ruled out. The army of economic experts, financiers and lawyers representing Greece are said to be deliberating over whether to add sweeteners to sway creditors into accepting the deal. As it currently stands, the proposal sees bondholders accepting to swap old bonds for new ones with maturities ranging between 20 to 30 years and a coupon of 4% to 5%.
Highlighting the significance of the moment, the Greek foreign ministry has this morning announced that the German foreign minister Guido Westerwelle will be making a surprise visit to Athens Sunday. He, too, will be dropping by Papademos’ office. Berlin, perhaps more than any other EU member, is especially interested in the outcome of the talks, having been the main provider of EU rescue loans for Greece so far.
12.10pm: US investment bank JP Morgan Chase has kicked off the Wall Street reporting season with fourth-quarter results. It posted lower profits as the European debt crisis dented trading and corporate deal-making.
The Wall Street bank reported net income of $3.7bn, or 90 cents a share, on revenues of $22.2bn. This is down from a profit of $4.83bn, or $1.12 a share, a year earlier.
11.41am: The euro fell to its day’s lows after the Italian bond auction failed to live up to traders’ high expectations, raised after a stellar Spanish bond sale yesterday. The single currency dropped to $1.2775 briefly before recovering somewhat to $1.2790.
11.13am: A quick look at the markets reveals that the FTSE is now just over 16 points ahead at 5679, a 0.3% gain, while Germany’s Dax is up 0.4% and France’s CAC has climbed 1%.
Chris Beauchamp, market analyst at IG Index, said:
As the sun rises on the final day of the trading week, the FTSE 100 is up slightly, but the atmosphere remains nervous.
For the second successive day, the morning focus is on a debt auction by one of the eurozone’s more troublesome members. Today, Italy is selling its debt, with the bulls hoping that Rome can emulate Madrid’s success yesterday. The auction saw yields fall, prompting the bulls to snort approvingly, but demand also dropped, which gave bears something to roar about. Ultimately, the market remained somewhat unimpressed, with the FTSE 100 remaining some distance from its early morning highs. Today’s blow-up is engineer Invensys, rudely shoved out of the leading index by Glencore in May last year, down 23% after a profit warning.
Looking ahead to the US open, US futures are slightly down, with the Dow expected to start around 12 points lower. The first reading of the January Michigan confidence index is out later today, while JP Morgan is the first of the major American banks to report its quarterly figures. An optimistic outlook from the bank could breathe new life into the markets, which have yet to push out of the narrow trading range seen so far in 2020.
11.10am: The consensus view seems to be that the Italian bond auction was “decent” but “not spectacular”. It failed to live up to some people’s expectations in the wake of Spain’s roaring success yesterday.
Michael Leister, strategist at DZ Bank in Frankfurt, told Reuters:
Today’s Italian three- to six-year taps attracted decent demand. The auction metrics look robust on aggregate, although not as spectacular as yesterday’s Spanish supply.
It is tempting to conclude from the Italian bill and bond auctions that PM Monti is rapidly regaining investors’ trust. We remain cautious, however, with regards to such a ‘fundamental’ interpretation. As we explained yesterday, the ECB carry-trade is by far the key driver of the recent outperformance of short-dated periphery bonds.
10.57am: Never mind Spain‘s successful bond auction yesterday – the country is going back into recession. Its economy secretary Fernando Jiménez Latorre warned a few minutes ago that the economy would shrink in the final three months of 2020 and the first quarter of this year:
Our forecast for the fourth quarter GDP is negative, and our forecast for the first quarter. is too.
It also emerged that Spanish banks borrowed close to record amounts from the European Central Bank last month as they took up its unprecedented offer of longer-term funds. Banks borrowed €132bn, compared with €106bn in November and a record high of €140bn in July 2020.
10.43am: Reaction from some analysts to the latest Italian government bond auction is a bit muted, following the euphoria at Spanish and Italian debt sales yesterday when Spain managed to sell sold twice the planned amount, backed by domestic banks awash with European Central Bank liquidity. Belgium also plans to sell up to €500m of longer-dated bonds today.
Peter Chatwell, rate strategist at Crédit Agricole, said:
They sold the maximum amount but prices look weak relative to the secondary market in the November 2020 and bid/cover ratios are lower than the market was expecting. I think in the euphoria of Spain’s auctions yesterday and [ECB president Mario] Draghi’s comments the market got carried away – this should help bring expectations back to earth.
Achilleas Georgolopoulos, rate strategist at Lloyds, neatly summed up the situation:
Taking into account what happened yesterday with the Spain auction, which raised expectations, it was much worse than what the market expected. And if we said for the Spanish auction domestic banks helped it’s probably that Italian banks have less available liquidity to participate.
But on an outright basis it was a decent auction, yields were lower, the bid/covers were OK. The market probably got too carried away as Spain raised double the size they had originally wanted to yesterday and so people were probably expecting the Italian bid/covers to be stronger than this.
10.31am: Italy’s three-year debt costs have fallen below 5%. Today’s long-awaited bond auction did not disappoint: The Italian Treasury has sold the entire €4.75bn of bonds it was looking to dispose of, with the yield at the 3-year auction hitting the lowest level since September.
Italy sold bonds maturing in November 2020 at an average rate of 4.83%, down from 5.62% it paid a fortnight ago. However, the bond sale was covered only 1.22 times compared with a bid-to-cover ratio of 1.36 at the end of Deember.
10.00am: Ben Bernanke presided over his first meeting as Federal Reserve chairman in March 2006 believing the U.S. economy could pull off a “soft landing” from falling home prices, AP reports.
Three months later, Bernanke had begun to grasp that he and others underestimated the risk housing posed to the economy. Newly released transcripts of Fed meetings during Bernanke’s first year as chairman show that, among Fed officials, he often expressed the most concern about housing. But no official, according to the transcripts, recognised the extent of the damage a housing bubble would cause. A year later, the housing market’s collapse helped send the nation into its worst recession since the Great Depression.
In fact, Treasury Secretary Timothy Geithner, then a Fed official, expressed confidence in September 2006 that “collateral damage” from housing could be avoided.
The transcripts for 2006 show that at first Bernanke did not express concern about the cooling of the housing market after a boom that had pushed sales and home prices to record levels. “I agree with most of the commentary that the strong fundamentals support a relatively soft landing in housing,” Bernanke told his follow FOMC members at his first meeting as chairman in March.
However, by the June meeting, Bernanke was expressing more caution saying that the slowdown in housing was “an asset price correction” that bore watching. “Like any other asset-price correction, it’s very hard to forecast, and consequently it’s an important risk and one that should lead us to be cautious in our policy decisions,” Bernanke said.
By the September meeting, Bernanke sounded even more concerned about the impact on the broader economy from the slowdown in housing.
“I don’t have quite as much confidence as some people around the table that there will be no spillover effect,” Bernanke said.
By contrast, Geithner, who was then president of the Fed’s New York regional bank, expressed more confidence that the economy could weather the troubles in housing, saying the issue would be the impact on consumer and business spending. “We just don’t see troubling signs yet of collateral damage and we are not expecting much,” Geithner said at the September FOMC meeting.
The discussion by the members of the FOMC, the Fed board members in Washington and 12 regional bank presidents, gave no indication that any of them foresaw the devastating impact that the collapse of the housing bubble would have. The country fell into a deep recession and severe financial crisis that led to the loss of more than 8 million jobs.
9.50am: Reaction to the producer price figures is trickling in. Philip Shaw, chief economist at Investec, said a sharp decline in consumer price inflation looks to be on the cards.
Samuel Tombs of Capital Economics said:
A sharp drop in both UK input and output price inflation in December had always looked likely, given the sharp rise in prices a year ago. Nonetheless, today’s figures confirm that disinflationary pressure in the economy is building.
Admittedly, output price inflation only affects consumer price inflation after a fairly long lag, so its fall will not do much to help inflation to drop this year. Nonetheless, at the margin, today’s figures should ease the concerns of some MPC members that inflation will not fall to a well-below target rate in 2020 and therefore increase the chances that the Committee will sanction more QE at next month’s meeting.
9.35am: Factory gate inflation in Britain weakened more than expected in December, boosting expectations that the Bank of England will pump more money into the economy next month.
The falling cost of raw materials allowed UK manufacturers to reduce the prices they charge for their goods in December for the first time since June 2020.
According to official figures, producer output prices dropped 0.2% on the month, taking the annual growth rate to 4.8%, the first fall since June 2020 and the lowest rate since December 2020. Oil prices rose at the slowest rate since November 2020 and chemical import costs also eased.
Input prices, a measure of manufacturers’ raw material costs, fell by 0.6% on the month while the annual rate plummeted from 13.6% to 8.7%.
9.01am: The yield, or interest rate, on ten-year Italian government bonds has fallen further below the 7% mark ahead of a bond sale which is expected to attract a lot of demand. Yields dropped 17 basis points to 6.48%, the lowest since 9 December. Two-year bond yields plummeted 40 basis points to 3.98%, the lowest since September.
Gary Jenkins at Swordfish Research says:
Of course for all the waves of optimism that seems to surge across the market on the back of such good news [yesterday’s successful Spanish and Italian bond auctions] there is also the realisation that this is just a small step down a very long road for both Italy and Spain. Italy has to raise some €440bn of debt this year and no doubt there will be close attention paid to their longer dated bond auctions which are taking place today.
8.25am: On the corporate front, Swiss pharma giant Novartis is slashing nearly 2,000 jobs in the US. The company is the latest drugmaker to cut its salesforce as the industry faces the biggest wave of patent expiries in its history.
Over here, Tesco is the target of several broker downgrades this morning, by UBS, HSBC, Citigroup and Barclays. The supermarket juggernaut is the biggest faller on the FTSE after reporting its worst Christmas in decades yesterday.
8.21am: Italy will sell €4.75bn of debt across three issues later this morning, including €3bn of 6% bonds maturing in 2020. The yield spread between Italian and German bonds narrowed ahead of the auction, which is expected to mirror yesterday’s success.
We are also getting UK producer price data for December at 9.30am.
8.07am: Stock markets are bouncing back. The FTSE has climbed more than 40 points to 5703, a 0.7% rise, in the first few minutes of trading. Germany’s Dax is 1% higher, France’s CAC and Spain’s Ibex have risen 0.9% while Italy’s FTSE MIB has advanced even more strongly, by 1.3%, ahead of a three-year bond auction.
Banks were the main risers. In London, Royal Bank of Scotland, Barclays and Lloyds Banking Group, along with miners Kazakhmys and Vedanta, led gains on the FTSE.
Brent crude oil is also going up, rising above $112 a barrel due to worries over supply disruption from Nigeria and receding fears over the eurozone debt crisis. Brent crude is now trading at $112.15 after rising more than $1 to $112.50 a barrel.
7.53am: The euro is up against the dollar this morning, amid stop-loss buying and hopes for a Greek bond swap deal. It hit $1.2879 earlier and is now trading at $1.2854.
The chief executive of French bank Société Générale, Frédéric Oudéa, told newspaper Les Echos that there is a good chance that a deal with private creditors to write down at least half the value of their Greek bonds will happen within the next few days.
Etes-vous optimiste sur l’issue des négociations sur l’échange de dette grecque ?
Elles ont de bonnes chances d’aboutir dans les prochains jours. Parmi les créanciers privés, les banques ont accepté de faire un effort exceptionnel. Il est possible que les pertes finales aillent au-delà de 50 %, mais il faut veiller à respecter un certain équilibre car même si les gouvernements s’attachent à dire que la Grèce sera un cas unique, il fera école pour les investisseurs. Il deviendra un « étalon du pire » qui risque de peser sur les autres pays.
7.42am: Good morning. We’re back with more live coverage of the European debt crisis and world economy.
The euro has rallied in the past 24 hours, thanks in large part to the successful Spanish and Italian bond auctions yesterday. Bond yields fell sharply as Spain sold €10bn, twice its target on the short dated debt, while Italy got its bonds away at half the interest rate it was paying last year. There is another Italian bond sale today, €3bn of three-year debt.
European stock markets are poised to open higher, with the FTSE 100 index in London seen rising more than 30 points to 5696.
Michael Hewson, market analyst at CMC Markets, said:
It has been speculated that the new 3-year LTROs [Long Term Refinancing Operations] initiated by the ECB last month have played a large part in the success of bringing yields down as banks take advantage of the low borrowing costs to play the carry on sovereign bond yields.
It remains to be seen whether banks and investors will be prepared to do that with longer term paper and that really remains the acid test, as to whether these lower borrowing costs are sustainable.
There is also speculation that the relaxation of capital rules, to be finalised next week could see the unlocking of trillions of extra euros with which banks can use for collateral to gain access to these ECB loans.
Today’s Italian bond auction of €3bn of three year debt, maturing in November 2020 is likely to go the same way as yesterday’s successful T-bill auctions, with lower yields, and certainly below the yields seen in December at around 5.62%, for similar terms.
How does Brexit affect the pound?
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During the past three years, the pound has had a rough time of things when it comes to its price against the dollar and other currencies.
The immediate aftermath of the Brexit referendum saw sterling decline sharply in value.
And as the vote on the UK’s withdrawal deal from the European Union looms, further volatility is expected.
Since June 2020, holidays and imported goods have become more expensive, but UK exports have been cheaper.
It’s a complex picture, though.
Exporters, such as carmakers, are importers themselves, buying in raw materials such as oil or copper.
While Britons living abroad but drawing a UK pension have suffered as the pound has declined.
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Why does the pound move?
Since 1992, the pound has floated freely on currency markets, meaning that traders – buyers and sellers – determine what it’s worth.
When the pound rises in value, more of the currency is being bought. When it goes down, more is sold.
“A free-floating currency is a very good thing, because it works as a safety valve,” says Jane Foley, senior currency strategist at Rabobank.
After the global financial crisis, countries whose economies suffered had weaker currencies. “Countries in the eurozone such as Greece and Spain had a strong euro they couldn’t devalue,” or reduce in value, she added, and for them, the safety valve was wage cuts.
“The downside is when it comes on the back of political uncertainty,” she said. “Goods become more expensive.”
Why does it react to the chance of a softer Brexit?
In recent years, traders have been looking at politics, rather than economic data, which means faster trading, and a faster pace of change in the price. That’s the volatility traders talk about.
“If you think abut political uncertainty being bad, the worst outcome is a hard Brexit,” says Ms Foley, because details of what will happen under those circumstances are so scarce.
“If that’s the worst case scenario, it [the pound] will rally if hard Brexit seems unlikely.”
Similarly, talk of putting Brexit on hold has boosted the pound, as it gives businesses more room to plan, she says.
A softer Brexit could be good news for savers, according to CIBC’s head of foreign exchange strategy, Jeremy Stretch.
Currency experts think that a softer Brexit could provide a boost to the economy by providing confidence and certainty to companies and consumers who in turn may decide to spend more or take on more staff.
That increased economic activity could prompt the Bank of England to raise interest rates, boosting returns for savers.
“We could see an interest rate hike come the May meeting of the Bank of England, although it may be the case that they wait until August,” according to Mr Stretch.
“Moving towards a softer Brexit would help to alleviate the uncertainty that was impacting the economy in the latter stages of 2020.”
What does that mean for buying holiday cash?
“Certainly since 2020, sterling is weaker,” says Ms Foley. “Our wealth overseas has lessened.”
At the bureau de change, rates will be even worse than those on the financial market.
That reflects their business costs including rent, staff, security and having lots of money ready. And if you buy your notes at the airport, convenience.
BBC research shows that travellers have seen bureau de change rates fall in recent months as the pound as suffered against other currencies.
But the value of the pound is always reflected in the price of another currency.
Which means that since the referendum there are some currencies against which sterling has performed better, notably the Turkish lira and the Argentine peso.
What other factors influence the pound?
Interest rates and money-printing can also have an effect. Higher interest rates, and therefore returns, may attract more foreign buyers, which pushes up the value of the currency.
Printing money, either literally or through the bond-buying programmes known as quantitative easing, has historically reduced the value of a currency by increasing its supply. But sometimes the effects can be minor.
Another factor is the UK’s current account deficit, says Jane Foley. That’s where imports exceed the value of a nation’s exports.
A simple way of thinking about it is a deficit of savers, she says. “We need foreign savers to make up the shortfall. If they don’t like what they see, they are more likely to pull their money out.” That means selling pounds and a cheaper currency.
“If we had a surplus, we would not be as vulnerable,” she says. It explains why the pound is more volatile – why trading happens at a faster rate – than the yen. Japan has much domestic wealth to draw upon.
Why is there so much buying and selling of currencies?
Companies may buy currencies for a variety of reasons. A company wanting to buy a UK-based rival will need lots of sterling to do so. It may have to sell dollars or euros and buy sterling.
Likewise, a company wanting to pay shareholders a slice of profits may need to bring UK sales home. They will sell their pounds.
Then you have traders who think they know something others don’t. They will make bets on the market, or speculation.
“Customers I see are corporate customers who may have to buy energy, grain or some other component,” says Ms Foley. “They have a natural need. It’s an easy mistake thinking it’s just speculators, making a quick buck.”
What do the experts think will happen to the pound?
Events will determine how the pound performs in the short term, until some sort of resolution for Britain’s departure from the EU comes about, said Ms Foley.
The vote on Prime Minster Theresa May’s Brexit deal will probably be the next event. Market-watchers have typically mixed views.
“The pound will react to the extent and manner of the government’s likely defeat in the vote, with a heavier defeat more likely to push down on an exchange rate that has already depreciated a great deal,” said Gregory Thwaites, research director at WorldRemit and previously Head of International Research at the Bank of England.
“In the unlikely event that the deal is passed, sterling will be likely to rally.”
“Should the withdrawal act be ratified on Tuesday, sterling will probably surge about 5% in value against the US dollar, but if December’s failed attempt is anything to go by then the chances look slim,” said Simon Harvey, market analyst at Monex Europe.
Hussein Sayed, chief market strategist at FXTM, said: “It is expected that the bill will be voted down, but this won’t be the most significant factor influencing the pound’s direction, it’s what will happen next.”
He says options as diverse as a no-confidence vote in the government, an extension of Article 50, a new general election and a second referendum could mean very different things for the pound. “As of now, investors seem to be on wait-and-see mode.”
European Sovereign Debt Crisis
What Was Europe’s Sovereign Debt Crisis?
The European sovereign debt crisis was a period when several European countries experienced the collapse of financial institutions, high government debt, and rapidly rising bond yield spreads in government securities.
- The European sovereign debt crisis began in 2008 with the collapse of Iceland’s banking system.
- Some of the contributing causes included the financial crisis of 2007 to 2008, and the Great Recession of 2008 through 2020.
- The crisis peaked between 2020 and 2020.
Sovereign Debt Overview
History of the Crisis
The debt crisis began in 2008 with the collapse of Iceland’s banking system, then spread primarily to Portugal, Italy, Ireland, Greece, and Spain in 2009. It has led to a loss of confidence in European businesses and economies.
The crisis was eventually controlled by the financial guarantees of European countries, who feared the collapse of the euro and financial contagion, and by the International Monetary Fund (IMF). Rating agencies downgraded several Eurozone countries’ debts.
Greece’s debt was, at one point, moved to junk status. Countries receiving bailout funds were required to meet austerity measures designed to slow down the growth of public-sector debt as part of the loan agreements.
Debt Crisis Contributing Causes
Some of the contributing causes included the financial crisis of 2007 to 2008, the Great Recession of 2008 to 2020, the real estate market crisis, and property bubbles in several countries. The peripheral states’ fiscal policies regarding government expenses and revenues also contributed.
By the end of 2009, the peripheral Eurozone member states of Greece, Spain, Ireland, Portugal, and Cyprus were unable to repay or refinance their government debt or bail out their beleaguered banks without the assistance of third-party financial institutions. These included the European Central Bank (ECB), the IMF, and, eventually, the European Financial Stability Facility (EFSF).
Also in 2009, Greece revealed that its previous government had grossly underreported its budget deficit, signifying a violation of EU policy and spurring fears of a euro collapse via political and financial contagion.
Seventeen Eurozone countries voted to create the EFSF in 2020, specifically to address and assist with the crisis. The European sovereign debt crisis peaked between 2020 and 2020.
With increasing fear of excessive sovereign debt, lenders demanded higher interest rates from Eurozone states in 2020, with high debt and deficit levels making it harder for these countries to finance their budget deficits when they were faced with overall low economic growth. Some affected countries raised taxes and slashed expenditures to combat the crisis, which contributed to social upset within their borders and a crisis of confidence in leadership, particularly in Greece. Several of these countries, including Greece, Portugal, and Ireland had their sovereign debt downgraded to junk status by international credit rating agencies during this crisis, worsening investor fears.
A 2020 report for the United States Congress stated, “The Eurozone debt crisis began in late 2009 when a new Greek government revealed that previous governments had been misreporting government budget data. Higher than expected deficit levels eroded investor confidence causing bond spreads to rise to unsustainable levels. Fears quickly spread that the fiscal positions and debt levels of a number of Eurozone countries were unsustainable.”
Greek Example of European Crisis
In early 2020, the developments were reflected in rising spreads on sovereign bond yields between the affected peripheral member states of Greece, Ireland, Portugal, Spain and, most notably, Germany.
The Greek yield diverged with Greece needing Eurozone assistance by May 2020. Greece received several bailouts from the EU and IMF over the following years in exchange for the adoption of EU-mandated austerity measures to cut public spending and a significant increase in taxes. The country’s economic recession continued. These measures, along with the economic situation, caused social unrest. With divided political and fiscal leadership, Greece faced sovereign default in June 2020.
The Greek citizens voted against a bailout and further EU austerity measures the following month. This decision raised the possibility that Greece might leave the European Monetary Union (EMU) entirely.
The withdrawal of a nation from the EMU would have been unprecedented, and if Greece had returned to using the Drachma, the speculated effects on its economy ranged from total economic collapse to a surprise recovery.
In the end, Greece remained part of the EMU and began to slowly show signs of recovery in subsequent years. Unemployment dropped from its high of over 27% to the 16% in five years, while annual GDP when from negative numbers to a projected rate of over two percent in that same time.
“Brexit” and the European Crisis
In June 2020, the United Kingdom voted to leave the European Union in a referendum. This vote fueled Eurosceptics across the continent, and speculation soared that other countries would leave the EU. After a drawn-out negotiation process, Brexit took place at 11pm Greenwich Mean Time, Jan. 31, 2020, and did not precipitate any groundswell of sentiment in other countries to depart the EMU.
It’s a common perception that this movement grew during the debt crisis, and campaigns have described the EU as a “sinking ship.” The UK referendum sent shock waves through the economy. Investors fled to safety, pushing several government yields to a negative value, and the British pound was at its lowest against the dollar since 1985. The S&P 500 and Dow Jones plunged, then recovered in the following weeks until they hit all-time highs as investors ran out of investment options because of the negative yields.
Italy and the European Debt Crisis
A combination of market volatility triggered by Brexit, questionable performance of politicians, and a poorly managed financial system worsened the situation for Italian banks in mid-2020. A staggering 17% of Italian loans, approximately $400 billion-worth, were junk, and the banks needed a significant bailout.
A full collapse of the Italian banks is arguably a bigger risk to the European economy than a Greek, Spanish, or Portuguese collapse because Italy’s economy is much larger. Italy has repeatedly asked for help from the EU, but the EU recently introduced “bail-in” rules that prohibit countries from bailing out financial institutions with taxpayer money without investors taking the first loss. Germany has been clear that the EU will not bend these rules for Italy.
Ireland followed Greece in requiring a bailout in November 2020, with Portugal following in May 2020. Italy and Spain were also vulnerable. Spain and Cyprus required official assistance in June 2020.
The situation in Ireland, Portugal, and Spain had improved by 2020, due to various fiscal reforms, domestic austerity measures, and other unique economic factors. However, the road to full economic recovery is anticipated to be a long one with an emerging banking crisis in Italy, instabilities that Brexit may trigger, and the economic impact of the COVID-19 outbreak as possible difficulties to overcome.
South African Rand: Moody’s Downgrade in the Price
Image © Natanael Ginting, Adobe Stock
The South African Rand could be relatively immune to a downgrade from Moody’s later on Friday, as the event has been well signposted to market participants and is therefore likely already absorbed by ZAR valuations.
The South African Rand has suffered alongside other emerging market currencies in 2020 as the global spread of the coronavirus update delivers a severe impact to global trade and investor sentiment. Therefore, it also becomes questionable as to how much a Moody’s downgrade actually matters given the scale of the external headwinds facing South Africa’s economy and its currency.
“We think the external backdrop is likely to remain the main driver of ZAR in the foreseeable future, overshadowing most domestic events,” says Daria Parkhomenko, FX Strategy Associate at RBC Capital Markets.
“If Moody’s gives South Africa a “pass” today, any boost to ZAR is likely to be temporary without a continuation of the recent USD selloff, a sustainable improvement in the risk backdrop, or significant progress in fiscal consolidation that removes the risk of a future downgrade altogether,” says Parkhomenko.
Moody’s will give its verdict at some point after U.S. markets close for the weekend.
Ahead of the decision, the Pound-to-Rand exchange rate is trading a full percent and a half higher at 21.43, its highest since June 2020. The Dollar-Rand exchange rate is at 17.51 while the Euro-Rand exchange rate is at 19.29.
Parkhomenko says if Moody’s downgrades South Africa, the hurdle for “new” negative news is high given consensus is expecting a downgrade to happen at some point this year. As such, the negative impact of a downgrade could be muted, as we have reflected in an earlier article here.
RBC Capital’s research modelling shows the market is already very heavily positioned against the Rand, when this occurs it becomes more difficult for a trade to extend. To put it simply, if the market is betting heavily in one direction it becomes harder to find more and more traders to engage in the bet, hence the pace of the Rand’s decline would lessen if the market is already heavily positioned against it.
RBC Capital also say foreigners have been lowering their exposure to South Africa’s local-currency government bonds since March 2020, and it is likely that at least the US-based investors have been hedging their FX exposure, which would limit the negative impact of forced selling of LC government bonds on ZAR due to a downgrade.
Moody’s is the last major agency to still have South Africa as an investment grade borrower and crucially, it is one of two that must rate South Africa as such a high quality borrower for the country to remain in the FTSE World Government Bond Index, once known as the Citi World Government Bond Index. And without inclusion in that index international fund managers who benchmark to it would be compelled to sell their South African government bonds, potentially inciting large outflows from the currency.
Foreign holdings of South African government debt were R316bn (£15 bn) in 2020 according to the statistical annexe included by Treasury in the February budget update and it was always thought that a large portion of that debt would end up being sold on the open market following a downgrade. However, foreign outflows from South Africa have picked up sharply in the last month since the budget and so much so the Rand may already have paid part of the price of a Moody’s downgrade. Jalinoos says there’s been around $4bn (£3.3bn) of outflows since February 20, which is equal to around 20% of foreign holdings.
“Moody’s will publish its rating decision after local markets close on Friday. When Moody’s conducts its coming review, South Africa government’s debt dynamics will look much worse than it did a few weeks ago,” says Shahab Jalinoos, head of FX strategy at Credit Suisse. “A downgrade will lead to an initial spike in USDZAR perhaps taking USDZAR 3%-4% higher initially (i.e. above 18.00 from current levels). Low liquidity in Asian trading hours on Monday could exacerbate the initial move.”
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Brexit Once Meant a Weaker British Pound, but Not Anymore
Britain’s currency has gained on the prospect that a Conservative victory will remove uncertainty about the break from the European Union.
LONDON — When Britain voted in 2020 to leave the European Union, its currency plummeted on world markets, reflecting agitation over the economic and financial disruption that seemed to lie ahead.
Three years later, with Brexit still not achieved, trading in the pound has been telling a different story.
After weeks of steady gains ahead of Thursday’s general election, the pound jumped as exit polls suggested a victory of the Conservatives and Prime Minister Boris Johnson, who campaigned on completing the rupture with Europe. The pound held on to most of its gains on Friday, after official results confirmed that the Conservatives had indeed won a majority.
In currencies, as in other markets, traders like certainty.
“The market sees a Tory majority as the best outcome in the short term,” said Lee Hardman, a currency economist at MUFG, a Japanese bank. “It gives you more clarity over the direction of Brexit.”
Global markets were buoyed on Friday by the results from Britain and the prospects of a partial trade deal between the United States and China. Asian and European stock indexes rose, with the Hong Kong’s Hang Seng up 2.6 percent and London’s FTSE 100 gaining 1.8 percent.
On Wall Street, stocks eked out a tiny gain after Chinese officials said they had agreed to the text of an initial trade deal with the United States, marking a significant de-escalation in the 19-month tariff war that has rattled the world economy.
The pound, a barometer of Brexit confidence since the 2020 vote to leave, has risen on the likelihood that a government with a working majority will be able to wrench Britain’s government out of its gridlock and spare the country from the potentially chaotic effects of leaving the European Union without a divorce agreement.
With a majority, Mr. Johnson will be better able to push through Parliament the withdrawal agreement he negotiated in October with the European Union. The outcome also means that Britain is likely to formally leave the European Union with a deal at the end of January.
The pound has gained more than 3 percent against the dollar since Parliament voted on Oct. 29 to hold a new election.
A stronger pound can be a bad thing for British companies, making it harder for them to sell their goods in the eurozone and beyond and diluting the profits they bring back from overseas. Nonetheless, British markets have also risen since the campaign began, reflecting the prospect of a Conservative victory that would not only reduce the chances of a no-deal Brexit but also avoid the nationalization ambitions of the opposition Labour Party.
The FTSE 250 is up more than 6 percent over that period, pushing the benchmark index of British stocks to a nearly 23 percent gain for the year.
“The market has become less worked up about the chance of a Labour government, and also some hope that a good-sized Conservative majority could kind of lift some Brexit uncertainty,” Andrew Wishart, United Kingdom economist for Capital Economics, a consulting firm, said before the voting.
Such signals have been a welcome development for the British economy, which has slowed since the 2020 referendum. Amid weak business investment and consumer confidence, economic growth fell to a 1 percent annual rate in the third quarter, the slowest pace in about a decade.
While the pound rallied in recent weeks, it is roughly 10 percent lower than it was immediately before the 2020 referendum. Markets were unprepared for the result, and in the hours after the vote the pound plummeted by about 10 percent. That is the equivalent of an earthquake in the normally subdued foreign-exchange markets. Daily moves of 1 percent are considered quite large for the currencies of rich nations like Britain.
Likewise, yields on government bonds remain low, despite the recent increase. The yield on the 10-year benchmark government bond, known as gilts in Britain, was roughly 0.8 percent in recent days, implying subdued expectations for growth and inflation in the coming years.
Analysts caution that any relief stemming from a Conservative victory may be short-lived.
“We think greater optimism about the ‘divorce deal’ being passed will soon give way to worries about the transition period,” wrote Paul Hollingsworth and Michael Green, United Kingdom economists with BNP Paribas, in a recent research note.
Even if a Conservative government manages to take Britain out of the European Union with a departure deal, it will have only 11 months to negotiate its future relationship with the bloc. Under the terms of the agreement negotiated by Mr. Johnson, his government would have until next December to negotiate a new trade deal — a process that usually takes years.
If he fails to do so, the country will again face a catastrophic split from its biggest trading partner. “The tough part is about to begin,” said Richard Falkenhäll, senior foreign exchange strategist at the Swedish bank SEB. “You would see a weaker sterling going into negotiations.”
Amie Tsang reported from London, and Matt Phillips from New York.
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