It was a pretty quiet overnight trading session as we head into Friday's New York trading session. The euro managed to pair earlier losses from the Asian trading session and managed to move above 1.38. In general, we saw the extension of the trend we have seen over the last week and a half as higher yielders gained at the expense of safe havens like the US dollar and Japanese yen.
Spain Downgrade Brushed Off by Euro
The euro had been softer as Spain's credit rating was downgraded by standard and poor's, which has been security for the third time in three years.
From Telegraph: Guillaume Menuet, Citigroup - S&P cited high unemployment, tightening credit conditions and a high level of public sector debt as some of the main reasons for the rating downgrade. It also noted the incomplete state of the labour market reform and the likelihood of a further deterioration for Spain's banks. Finally, it cut the 2012 GDP forecast to 1pc from 1.5pc, warning about growing recession risks.
We share many of the rating agencies' concerns regarding the economy. Our recent note: Spain - Tough Tasks For The New Government- warns that fiscal slippages and a worsening economic environment are likely to offset any positive news from the election results. Together with a likely economic recession in 2012, this makes the medium-term fiscal target - a deficit of 3pc of GDP by 2013 - very difficult to achieve, in our view.
With downgrades of Spain coming earlier last week perhaps the expectation here was already built into the market and therefore the did not have a major impact in shifting the sentiment in currency markets.
The bigger impact may have come from Fitch, which downgraded several European banks, highlighting the danger of contagion to Europe.
From Marketwatch: Fitch Ratings on Thursday downgraded four European banks and placed seven more international institutions on review for possible downgrade, citing a broad review of their mounting regulatory burdens alongside new challenges facing financial markets.
Fitch Ratings on Thursday downgraded four European banks and placed seven more international institutions on review for possible downgrade, citing a broad review of their mounting regulatory burdens alongside new challenges facing financial markets.
EFSF is Ratified, Now How to Leverage it?
Countering that negative development we do finally have the full ratification of the EFS F changes by all of the European Parliament's that are in the euro zone and that means that the bailout funds which until now could only issue bonds to pay for bailout packages can now also by periphery debt on the secondary market, provide aid to struggling banks, as well as offer credit lines to countries under attack.
The fact that it took three months for the EFSF changes to be approved from when they were first agreed-upon shows the problem that the euro zone has in implementing emergency measures when unanimous consensus and parliamentary approval is needed for such significant changes.
Now that the EFSF is online, the main question is its firepower which could be increased by using some leveraging measures such as insuring a portion of new bonds issued by debt ridden nations.
G-20 Meeting Brings Some More Optimism
Today we start a meeting of G-20 finance ministers and central bankers and this has created some optimism in the currency markets as the reporting out of the meeting says good members are focusing and outlining a rescue plan for the euro zone. This includes their increasing possibility of Greek bondholders will take further losses, that banks will be recapitalized with higher capital levels, and that emerging markets and the rest of the G 20 members may increase the IMF's current bond in order to give it the capability to help should the global economy worsen. Currently the IMF has 390 billion-dollar cash pile which may not be large enough according to its managing director Christine Lagarde.
Therefore let's watch for any announcements that emerging markets are willing to top off the current IMF funds, which which could give it more scope to help provide more support to the Euro-zone countries efforts. such an announcement would be taken as a positive for risk sentiment and should benefit the euro as well as other higher-yielding currencies.