As soon as the risk-on instruments started to pop on rumors of a German-French agreement on the future of the euro zone, Standard & Poor’s announced that 15 euro-area nations are placed on negative watch list for possible downgrades. Germany and France are not protected from these downgrades. The announcement initiated risk-aversion moves all over the market which continued through the Asian session with Asian stocks falling down.
S&P could downgrade Austria, Belgium, Finland, Germany, Luxembourg and Netherlands by one notch and downgrade Italy and France by two notches.
The S&P highlighted 5 factors contributing to the increase of risk:
1. Tightening credit conditions
2.Much higher risk premiums 3. Continuous disagreement amongst European policy-makers on how to restore market confidence and how to tackle longer-term economic and fiscal challenges 4. High level of government and household indebtness 5. The growing risk of a eurozone recession The S&P is expected to act quickly and will have an announcement this Friday, after the EU summit. That means that European leaders will have to come up with something in order to avoid another negative downgrade or at least negative announcement from S&P and other rating agencies. I wonder how they will do that.
The moves we saw yesterday confirm our view that the markets are very thin and very vulnerable to any rumor or comment. The euro popped higher on the “Merkozy” announcement then lost all the gains it made during the day when the S&P announcement was made. The trading strategy remains the same, it’s been working for months now, it worked yesterday and it is expected to keep on working in (at least) the near future. Shorting on retraces is the best trading strategy you can have at these moments. Don’t complicate things; keep it as simple as possible.
We’re expecting markets to fall in some kind of a range for the next few days awaiting the EU summit and what can come out from rating agencies but that doesn’t mean we recommend buying at the bottom of the range. As we said, just shorting these markets seems to be the best way to play it.