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S&P Downgrades Europe

01/18/2012

At the end of last week, Standard & Poor’s downgraded the long-term credit ratings on nine sovereigns while affirming the ratings on seven other eurozone nations.  Keep in mind – back on December 5, 2011, S&P placed euro nations on review for a possible downgrade. In addition, on January 16, the European Financial Stability Facility (EFSF) was cut from AAA to AA+.
 
RATINGS CUT:
 
•         Austria                cut to AA+/Negative/A-1+            from                   AAA/Watch Negative/A-1+
•         Cyprus                cut to BB+/Negative/B                 from                   BBB/Watch Negative/A-3
•         France                cut to AA+/Negative/A-1+             from                   AAA/Watch Negative/A-1+
•         Italy                    cut to BBB+/Negative/A-2             from                   A/Watch Negative/A-1
•         Malta                  cut to A-/Negative/A-2                   from                   A/Watch Negative/A-1
•         Portugal              cut to BB/Negative/B                    from                   BBB-/Watch Negative/A-3
•         Slovak Republic   cut to A/Stable/A-1                       from                   A+/Watch Negative/A-1
•         Slovenia              cut to A+/Negative/A-1                  from                   AA-/Watch Negative/A-1+
•         Spain                  cut to A/Negative/A-1                    from                   AA-/Watch Negative/A-1+
 
 
RATINGS AFFIRMED:
 
•         Belgium          revised to AA/Negative/A-1+               from                   AA/Watch Negative/A-1+
•         Estonia           revised to AA-/Negative/A-1+              from                   AA-/Watch Negative/A-1+
•         Finland           revised to AAA/Negative/A-1+             from                   AAA/Watch Negative/A-1+
•         Germany        revised to AAA/Stable/A-1+                from                   AAA/Watch Negative/A-1+
•         Ireland            revised to BBB+/Negative/A-2             from                   BBB+/Watch Negative/A-2
•         Luxembourg    revised to AAA/Negative/A-1+             from                   AAA/Watch NegativeA-1+
•         Netherlands    revised to AAA/Negative/A-1+             from                   AAA/Watch Negative/A-1+
 
 
I purposely waited until mid-morning on Wednesday, January 18, to gauge the most important factor relative to the downgrades:  How are the credit markets reacting? In what can be perceived as a classic example of “bad news, good price action,” European credit markets continue to trade with improved conditions relative to the end of 2011.
 
 
Government bond auctions in the wake of the downgrades (all this week):
 
•   Spain sold 4.88 billion of 12- & 18-month paper versus its 5 billion euro target

o   12-month yield was 2.049% versus 4.05% on Dec 13
o   18-month yield was 2.399% versus 4.23% on Dec 13

•    EFSF sold 4.66 billion of 182-day bills versus target of 1.5 billion euros
 
•   Germany sold 7.60 billion of 2-year debt versus target of 4 billion euros
 
•   Portugal sold the maximum target of 2.5 billion euros in a debt sale of 3-, 6-, & 11-month T-Bills

o   11-month yield was 4.986% versus the previous 11-month sale on April 6 of 5.902%

The three charts below highlight the favorable price action in the eurocurrency, Italian 10-year bond, and Spanish 10-year bond since the downgrades. I suspect much of the improvement is engineered by the ECB increasing its government bond purchases. In fact for the week ending January 13, the ECB purchased 3.77 billion euros of sovereign bonds. That is a significant increase from the previous week’s 1.1 billion euros’ worth of bond purchases. Ultimately, the ECB continuing to buy sovereign debt is a necessary component to navigating the crisis.
 
 
EUROCURRENCY

Source: Bloomberg
 
ITALIAN 10-YEAR GOVERNMENT BOND

Source: Bloomberg
 
SPANISH 10-YEAR GOVERNMENT BOND

Source: Bloomberg

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