Don't forget that you can now follow Forex.com's research team on Twitter: http://twitter.com/forexresearch
The S&P put 15 members of the Eurozone (excluding Cyprus and Greece) on credit watch negative last night, saying that in recent weeks systemic stresses in the Eurozone have risen. Anyone who has been following the markets would have known that systemic risks have risen, so it should come as no surprise that even the top-rated Eurozone countries (there are 6 AAA-rated countries in the currency bloc) are now under threat.
But it was the timing of the S&P move that shocked the markets. The EU summit is coming up on Thursday and Friday and yesterday's Franco/ German summit took steps to make structural changes to the currency bloc that - if put in place - could alleviate the current situation and help public finances get back on the straight and narrow. Although the markets might like the progress, the S&P gave us all a reality check since the cure to the current problem could also be a curse, especially for those nations with strong finances.
The S&P said that it would look at political, external and monetary scores over the next 90 days for the governments it put on downgrade watch before it decides whether to downgrade or not. The trouble is that the Eurozone's sovereign and banking sectors are already so intertwined that one downgrade sets off a sort of domino effect.
So, if we get closer fiscal integration as a result of this week's summit then it could trigger downgrades of the triple-A rated countries since they are on the hook for more profligate less credit-worthy sovereign debts. But if the top-rated countries are downgraded then this threatens the EFSF's credit-rating making it more difficult to help weaker sovereigns in need, which also threatens their credit rating. Added to this, the close relationship between sovereigns and the banking sector could trigger a wave of downgrades for financial services and even corporates who rely on banks' for cash-flow purposes. So, even though we are fully focused on the EU summit, the next 3 months are going to be critical for the Eurozone as it tries to ensure its top-rated members stay that way.
The market reaction to the news was fairly sharp. Since European markets had closed by the time of the announcement stocks in Europe opened lower this morning led by the banking sector. Likewise, the euro came off its highs and is now stuck in a tight range between 1.3370- 1.3400. Interestingly, mid-way through the London morning stocks are actually starting to recover and the Eurostoxx banking index is close to yesterday's highs. Most of the G-10 crosses in FX are mirroring the fortunes of EURUSD. The markets don't know how to digest the S&P news: if the outcome of the summit means fiscal integration will that stave off a default or cause one? So expect range-trading conditions for the next couple of days.
Likewise, Eurozone bond yields have been more mixed today. Italian 10-year yields did drop below 6% at one stage but are slowly creeping higher, however they remain 150 bp below last week's level. The bond market is balancing two opposing factors today: on the one side there is the announcement from Merkel yesterday that private sector involvement in a Greek restructuring or haircut has been dropped - this should give the holders of Eurozone debt some certainty that their investment is safe. However, on the other side, a threat of a credit rating downgrade should keep the pressure on yields, so it could be a choppy week across asset classes.
Economic data is in focus today. Halifax UK house price data was dismal for November dropping 0.9% on the month. Likewise, BRC retail sales data for last month was also weaker than expected, falling 1.6%. Sterling continues to react in line with the euro and overall risk appetite especially against the dollar. EURGBP is stuck in an incredibly tight range between 0.8540-0.8560 - a key support zone. We expect it to remain range-bound until we get direction from Europe's leaders on Friday.
EURCHF has bucked the range-bound trend and jumped 80 pips on some very weak Swiss CPI data. The annual inflation rate fell to -0.5%, from -0.1% in October, the lowest level since October 2009. The SNB has said that a strong franc threatened to push the country into deflation and today's data may be all the evidence the Bank needs to raise the EURCHF floor to 1.25, as is widely rumoured, at its next policy meeting on 15th December.
Kathleen Brooks| Research Director UK EMEA | FOREX.com
d: +44.(0).20.7429.7924 | f: +44.(0).20.7929.2010 | M: +44 (0) 7919.411.957 | e: email@example.com| w: www.forex.com/uk
23 College Hill | 3rd Floor | London EC4R 2RT
Now you can follow us on Twitter: http://twitter.com/forexresearch
Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency or CFD contract. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. Any references to historical price movements or levels is informational based on our analysis and we do not represent or warranty that any such movements or levels are likely to reoccur in the future. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.
Foreign Exchange and other leveraged products involves significant risk of loss and is not suitable for all investors. Increasing leverage increases risk. Spot Gold and Silver contracts are not subject to regulation under the U.S. Commodity Exchange Act. Contracts for Difference (CFDs) are not available for US residents. Before deciding to trade forex, you should carefully consider your financial objectives, level of experience and risk appetite. Any opinions, news, research, analyses, prices or other information contained herein is intended as general information about the subject matter covered and is provided with the understanding that FOREX.com is not rendering investment, legal, or tax advice. You should consult with appropriate counsel or other advisors on all investment, legal, or tax matters. FOREX.com is regulated by the Commodity Futures Trading Commission (CFTC) in the US, by the Financial Services Authority (FSA) in the UK, the Australian Securities and Investment Commission (ASIC) in Australia, and the Financial Services Agency (FSA) in Japan.