S&P versus ECB

Last night we saw the first salvo in a long war between the rating agencies and the ECB’s emergency action to prevent total European financial melt-down. The ECB came out on top, with France selling 1.9 billion euros of one-year notes today at a yield of 0.406 percent, down from 0.454 percent. The European equities market received the news well and jumped on the result. Given the recent sub-3 year issuance results this wasn’t really a surprise, but it did provide some much needed good news.

Although the market appears to have taken the downgrade of France in its stride, the junking of Portugal is a different matter. The Portuguese 10yr yield jumped 15.6% overnight. This result isn’t an immediate issue given the fact that the country is already on life support, but the result is likely to be yet another hit to the banking sector, specifically German and Spanish banks from the looks of recent data:

It would appear that Portugal is slowly slipping in the direction of Greece. The latest report from the country’s central bank certainly isn’t happy reading:

The forecasts released Tuesday by the Portuguese central bank are the gloomiest to date and predict a worrying contraction for the Portuguese economy: 2012 should register a 3.1% contraction from the 2.2% forecast just three months ago. The scenario is described in the Bank of Portugal’s winter bulletin released today as ”an unprecedented contraction of the Portuguese economic activity“, brought on by austerity measures and the growing uncertainty surrounding the crisis in the eurozone.

The Portuguese central bank forecasts a 3.1% contraction in 2012 and a virtual stagnation in 2013, when the country’s economy should grow just 0.3%. However, the forecasts for 2011 were revised slightly upward, to 1.6% from last October’s forecast of a 1.9% fall.

Internal demand, the main driver of next year’s contraction, also registered a significant worsening in the central bank’s winter bulletin. The Bank of Portugal is now expecting a 6.5% fall from the 4.8% contraction forecast for 2012, as the country is in the grip of a huge austerity drive which has brought on an overall increase in prices, tax hikes, and cuts to wages and benefits as part of the government’s policies, as it strives to comply with the €78bn bailout agreement signed with the European Central Bank, the International Monetary Fund and the European Commission, in 2011.

Yields on Spanish and Italian bonds hardly moved overnight suggesting that the ECB’s SMP program was once again busy. The ECB was very active last week with €3.77bn in sovereign purchases, up from  €1.1bn the week before. That is the highest level of activity for 3 months and I see no reason to suggest that pace will slow.

After the market closed S&P released yet another well-choreographed salvo on Europe with the downgrade of the EFSF:

The European Financial Stability Facility lost its top credit rating at Standard & Poor’s after the rating company downgraded France and Austria.

The rating was lowered to AA+ from AAA, S&P said in a statement today. It had said on Dec. 6 that the loss of an AAA rating by any one of the EFSF’s guarantor nations may lead to the facility being downgraded.

“The EFSF’s obligations are no longer fully supported either by guarantees from EFSF members rated AAA by S&P, or by AAA rated securities,” the company said. “Credit enhancements sufficient to offset what we view as the reduced creditworthiness of guarantors are currently not in place.”

S&P removed the ratings on the facility from CreditWatch with negative implications, it also said.

And then the return fire from the ECB:

European Central Bank chief Mario Draghi on Monday downplayed the importance of ratings agencies after Standard & Poor’s mass downgrade of eurozone countries, saying markets had priced in the action.

“I think what we should do is to learn either to do without them or with them but to a much more limited way than we do today,” said Draghi, in his capacity as head of the European Systemic Risk Board (ESRB).

“To a great extent, markets anticipated these ratings changes and priced their assets as if these ratings had already been issued,” said Draghi, speaking at the European Parliament in Strasbourg.

There is no doubt that these ratings were already priced in by the markets. There have been rumours circulating about the downgrade of France for over a month and even the French finance minister had stated that it would be a miracle if France was able to keep the top rating. What I don’t think has been priced in by the markets, as I discussed yesterday, is S&P’s negative outlook based on the continuation of the current policies. As far a I can tell, the response from the European leadership thus far has been to re-state their commitment to the “fiscal compact” with a few addition motherhood statements about “focussing on growth”. The problem is that most of what S&P warned about in their ratings assessment is the exact plan Europe currently has for itself.

Mario Draghi may consider the rating agencies to be irrelevant but the big swing in the Portuguese yields suggest many others don’t share his view and the problem for the European banks is that , at this stage, neither does the ECB’s operating procedure:

Italian banks need additional collateral to obtain funding after the country’s credit rating was cut by Standard & Poor’s and the London Clearing House raised its margin calls on Italian bonds, Deutsche Bank AG (DBK) said.

“These points are negative for the Italian banks, for the pressure on their sovereign holdings and on interbanking funding,” Paola Sabbione, a Milan-based analyst at Deutsche Bank, said in a note to investors. “A larger collateral is now required to obtain the same ECB funding.”

Although markets had already anticipated the moves by the rating agencies, I am very doubtful they have priced in what is happening in Greece.

Greece sent senior officials to Washington on Monday for meetings with the International Monetary Fund (IMF) as it raced against the clock to break a deadlock in debt swap talks that has prompted new fears of an unruly default.

Barely a month after an injection of bailout funds helped avert bankruptcy, Greece is back at the centre of the eurozone crisis as fears of a default and a subsequent eurozone exit overshadow a mass credit downgrade of eurozone countries.

Athens needs a deal with the private sector within days to avoid going bankrupt when €14.5bn of bond redemptions fall due in late March. But talks with its creditor banks broke down without an agreement on Friday.

Charles Dallara, head of the Institute of International Finance who represents Greece’s private creditors, told the Financial Times an agreement in principle was needed by the end of this week if it was to be finalised in time for the March bond redemptions. He said the Greeks were not the problem.

“All the European heads of state said they wanted a deal with a 50% (haircut) and a voluntary agreement,” Dallara was quoted as saying. “Some of their own collaborators are not following that decision.”

After initial optimism last week that a deal was near, negotiations stalled on Friday over the interest rate Greece must pay on new bonds it offers.

One banking source said official sector creditors had asked for a coupon of less than 4%, irking banks for whom it would have meant losses of over 75% on the bonds.

A second source said the banks were ready to strike a deal if they reached common ground with the EU, IMF and ECB.

German and French officials have now been called in to help break the deadlock between parties. The disagreement appears to be focussed on what coupon will be paid on a 30 year bond and also the involvement of non-private parties. Greece faces a €14.4bn redemption payment in March and needs to have the second bailout programme in place to avoid a default. I have long stated that Greece will eventually default. Even if this deal does get through and Greece eventually gets yet another bailout I doubt it will be too long before Greece is back at the negotiating table asking once again for additional funds. Supposedly Greece has just 45 days to avoid default.

All of these downside risks and the actions of the ECB are slowing taking their toll on the euro. At this stage the masters of other currencies appear to be waiting and watching, but Japan is becoming increasingly concerned about the currency’s weakness against the Yen. FT is reporting today that Japan may intervene in the euro market for the first time in nine years.

How long before the US gets restive about its currency too?

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  1. +1

    I think the EU will fight hard to keep Greece afloat, but looking at the yields no one believes they will be successful, and if Greece does go down, no number of bandaids are going give us stability.

  2. so now we are back to worrying about minnows like greece and portugal? the severity of the crisis has certainly dropped back a few gears…

    • I think they will only keep Greece afloat for as long as default means setting of a cascading effect on Italy, Spain etc.

      As soon as Greece has been isolated and default will no longer mean collapse of other member states (either by bringing down Greece’s debt or fortifying the other member states) default will occur.

      I just hope the panicking will die down a bit so the EU can shift its attention to addressing the macro-issues DE has been writing about.

      • i dont there will be a “defualt” Anan. Not one that meets ISDA definitions anyway. So, if ISDA doesnt classify a deault as a default and it doesnt trigger CDS payments it doesn matter weather they default or not. but if they do defualt and they probably will, it wont be called a defualt anyway.

      • The CDS thing is the threat.
        Who holds the exposure , how great is it, who goes under if they are triggered?

        I really must get on and work this CDS style risk insurance scam to my benefit.
        How about I insure my motor vehicle under 33 different policies world wide? Reckon that’ll work??
        PS I don’t own a motor vehicle.

        • CDS works both ways…


          Another potential challenge comes from the hedge funds. There have been press reports that some hedge funds have reportedly been buying Greek bonds with the idea in mind to refuse to participate in the PSI. The argument is that in this case it could become a credit event that triggers the CDS they own on Greece. Alternatively, the Greek government pays the hedge funds off in full.

          Reuters (Jan 10) called the positions accumulated by the hedge funds as “powerful”. Bloomberg reports have claimed that hedge funds have “amassed stakes”. But none one seems to know how much Greek bonds have been acquired by the hedge funds.

          Reports list 4-5 hedge funds by name. An estimated 20-25% of Greek bond holdings are not unidentified. This is where the hedge funds are likely to be found. There are some estimates that the hedge funds could account to half of the unidentified creditors.

          • Good work by the hedgies to protect themselves like that.
            I insure some one else’s motor vehicle, then I Tbone ’em.

            More seriously how can I know who the money is behind the ISDA?
            Who is running that show at the moment?

    • > so now we are back to worrying about minnows like greece and portugal? the severity of the crisis has certainly dropped back a few gears…

      I think the immediacy of the crisis has certainly dropped back, but as AnonNL noted, until we actually see a resolution of the fundamental problems of the single currency and the competitiveness imbalance the crisis will remain.

      The imbalances are currently been worn by the ECB’s balance sheet but this is not a permanent fix. That is pretty much what S&P said yesterday as part of their downgrade.

      Another big concern of mine, that I didn’t mention in the post, is that the internal politics of the European political machine start interfering with the ECB. which at this point is the ONLY thing holding up Europe.


      Given the LTRO and the SMP you could pass this stuff of as jaw-boning but I detect that Germany and France are beginning to reach the end of their political tethers when it comes to dealing with the crisis.

      France is a weak-point here IMHO. As the French economy slows in the lead up to the election it is likely that Sarkozy will come under political pressure at home to explain why French citizens should continue to pay for the weak periphery when they need the additional resources at home.

      • i think everyone in europe nows understands the severity of the crisis, that it needs a united front, and the pereiphery needs support and if it doesnt get it they all go under.

        most importantly though europe needs a real central bank with all the tools that a real central bank should have at its disposal including the ability to print.

        the vast majority of people in europe want to keep the euro so thats the way policy makers will go.

        13% devaluation in the EUR over the last few months will help and there is another LTRO (quassi QE) next month all helping bring the crisi under control

        • I agree. It’s just that Germany does not want to sign an unconditional blank check… but they do know a big check they’ll need to sign nevertheless. It’s for their own good. They just want to profit as much as possible from this big check, obviously.

        • >most importantly though europe needs a real central bank with all the tools that a real central bank should have at its disposal including the ability to print.

          Well I would go further, in truth Europe requires a central fiscal authority with the ability to transfer capital across Europe’s borders in the same way that the OZ or US government can.

          This requires ALL euro nations to become states of Europe and give up their fiscal sovereignty.

          This is a step too far for the Europe of 2012 IMHO

          • > This requires ALL euro nations to become states of Europe and give up their fiscal sovereignty.

            It’s more like all euro nations to become states of Germany 🙂

          • SSEC: It doesn’t have to be.

            Federation would mean finally being able to implement a proper framework with decent checks and balances and being able to balance power between the states (eg. equal representation in Senate, proportional in House of Reps like in the US – the one thing the US got right is their checks and balances and structure of government).

            That’s the paradox here… everyone is afraid of federation, loss of sovereignty, lack of transparency, broken democracy, technocrats, bureaucrats etc… but all that is only occurring because we don’t have the balls to take a couple of steps forward and organize things properly!

          • Anon, I agree… it’s just that it feels like that right now… the periphery is paying massive rates on debt while Germany (and France and others) are paying just a fraction of that.

            However, all countries share the same currency, inflation targets, central bank, etc. being in a monetary union also means helping each other economically when times are tough! Germany and France were among the first nations to break the budgetary rules by the way. In a sense, for the EU is now make or break.

            Germany does not want to sign a blank check, but the time will come soon where they to have to decide if they want to commit or not. I think and hope they will commit, as the advantages of the European Union are far more than the disadvantages, including peaceful living.

            PS to simplify by “Germany” I do mean and include the Netherlands too: the Dutch economy is as strong as the German one, if not better.

          • I fully agree SSEC. I cringe when I look what a narrow minded, small country The Netherlands has become in a matter of a couple of years.

            I think the EU should start with diverting its regional development funds to employment projects in Spain, Italy, Greece… stick a big fat EU flag on it to show another side as well. It’s a small gesture, but better than nothing.

            Time for a real EU Marshall plan!

  3. On a different note… I just read this:

    Speaking after Standard & Poor’s stripped France and Austria of their prized triple-A ratings and downgraded Italy, Portugal, Spain, Cyprus, Malta, the Slovak Republic and Slovenia, Ms Gillard said the moves were the “price to be paid by national governments who have put off tough reforms”.

    “For too many years, European governments have deferred the nation-building productivity-enhancing reforms which Australia has made the foundation of our dynamic and resilient economy”

    Without trying to go all nationalistic EU vs Oz… that has to be the biggest pile of BS I have read in a long, long time. If any government is crap at governing and reform it has to be Australia’s… not to speak about this claim of Oz’ economy being highly dynamic!

    Steam coming out of my ears now… 😛

    • “For too many years, European governments have deferred the nation-building productivity-enhancing reforms which Australia has made the foundation of our dynamic and resilient economy”

      bwahahahahahahaha! the frightening thing is that Gillard actually believes this stuff.

  4. I live & work in Greece and i can categorically tell you GB that Europeans DO NOT get the seriousness of the situation. I don’t mean the internet-blogging-capital-markets-employed public, but the other 98% of the public.

    A summary of Greece at the moment:
    * Greek politicians are paralysed by party factionalism & have 1.5 eyes on the next election
    * the unions are against ANY crimping of “hard won labour rights” & use strike action to kill any initiative (4 National strikes in 2011 & 14 public transport stoppages in Athens in 2011 – a city of 5 million people wholly dependant on it)
    * the business community are only interested in using their contacts in the Tax Dept to avoid any painful restructuring (think tax avoidance & gov’t largesse)
    * and the Troika (ECB/IMF/EU) is in la la land. Every Troika review ends with incredulity at the non-existence of Greek gov’t compliance with any memorandum obligations, yet the Gov’t knows the Troika won’t allow Greece to default, so as soon as they board their flight the gov’t ceases any attempt to comply.

    The EU is riven by national interest (the Iran issue recently was clear evidence of that). The primary issue is simple: the Club MEd countries just do not WANT to be like Germany (or Northern Europe generally – sorry AnonNL, it’s not personal). Efficiency & productivity are concepts that just don’t register with any lasting seriousness. These debts have doomed southern europe and the politicians will never get their countrymen to pay for them (the tax stories i hear just beggar belief). The average European citizen is confronted by a giant enterprise called the “EU” & finds it impossible to reconcile all the competing pressures & issues re sovereign debt, currency, EFSF, rating agencies with their personal tax bill and day-to-day drive to survive. The currency union will kill the federalist drive and take us back to the EEA, probably for a generation.

    The ONLY issue on the table now is how fast everyone can get to the lifeboats before the magazines explode. The best the Europoliticians can hope for is soft and hard Euro currency areas, split by the those who would print & the Germans. I give it 6 months…

    (apologies for the essay. people in Oz need to understand that the homogeneity that Aussies or Americans can bring to a problem just does not exist here. 2 years of trying to warn people of this from here is making me irritable)…

    • I think the rigid stance of Germany, NL etc can probably be explained by frustration with the lack of reform you describe. Just because Greece has them by the balls doesn’t mean Greece will come out tops in the end. The Dutch Minister of Finance has repeatedly outed his frustration with the Greeks, for example by saying that “we” passed the point of simply trusting the Greeks to do what they promise quite some time ago.

      This whole crisis has done considerable damage to Greece’s reputation and they will be paying for decades to come by having to face distrust from other member states and businesses. They basically have placed themselves all the way at the back of the line for any future initiatives and benefits. Also, don’t underestimate the influence the Northern memberstates will have for quite some time, in part because this crisis will take a long time to solve. We’re talking about a change in culture here which is not something done in 2 years or so. We may be seeing the first signs changes 10 years down the road or so…

      P.S. Don’t apologise for any criticism regarding my home country. The moment national pride prevents listening to constructive criticism things usually go downhill… I’m very focal about things I think can be improved in Oz, so by all means, bring it on. 😛

    • Phew, that’s a breath of fresh air. I was worried that Greeks might be getting taken in by all that ridiculous obeisance to “German efficiency”. Who needs it?

      On a darker note, the Germans are just as corrupt as the Greeks, they are just better at hiding it and getting their own way. Selling submarines and artillery to a country that can’t afford them via vendor financing and bribery is rather worse in my book than forgetting to keep a record of cash transactions for tax purposes. These things have two sides.

  5. thank the gods for that!! now the chinese can buy up some EFSF debt and …what? oh…

    well at least Gillard brings some comic relief