Danske Daily

Belgium was downgraded to Aa3 by Moody's on Friday – Fitch puts Spain and Italy on review for a possible downgrade

US stocks closed with minor gains, but risk off has returned in Asian trading

US senate passes payroll tax cut bill – focus turns to the House of Representatives

North Korean leader Kim Jong Il is reported to have died

Thin calendar today – ECB 36M LTRO and Swedish rate decision later this week

Markets Overnight

While the market awaits the verdict of Standard & Poor‟s (15 eurozone countries were put on review for possible downgrade on 5 December), the other two main rating agencies announced changes on Friday. Belgium’s credit rating has been lowered two levels to Aa3 by Moody‟s, while Fitch lowered its outlook on France to ‘negative’ and put Spain and Italy on review for a possible downgrade.

As we argue in Government Bonds Weekly we expect bond spreads to be driven by the conclusion of the ongoing review in the short term. We still do not expect a downgrade of Germany and hence see a one-notch downgrade of France (and hence also the EFSF) combined with a negative outlook on Germany and the other AAA‟s as the most negative of the likely outcomes.

European sovereign spreads widened somewhat on Friday as the non-core countries failed to follow the drop in German yields. Eurozone finance ministers will hold a conference call today at 15:30 CET to discuss the EUR200bn in additional funding through the IMF and the details of the „fiscal compact‟ that was negotiated at the 9 December summit, according to Bloomberg.

US stocks closed with minor gains on Friday, but risk sentiment has weakened over the weekend and Asian markets are trading in red. At the time of writing, the Nikkei index is down more than 1% and the Hang Seng has lost about 2.5%. Losses have been amplified by the announced death of North Korean leader Kim Jong Il.

EUR/USD has traded fairly stable around the 1.30 level, but a falling oil price (Brent is trading below USD103 per bbl) and a further decline in the positive EUR carry is expected to see pressure remain on the single currency.

Besides potential rating action, the key events this week are the ECB‟s 36 month LTRO, the Swedish rate decision, and German IFO survey.


Global Daily

Focus today: The calendar is very thin today. The US NAHB housing market index will attract some attention in the afternoon. We will get more data on the housing market during the week and we expect these data to show slightly stronger activity while house prices remain under pressure. In the late afternoon ECB's Mario Draghi will speak to the European Parliament (look for signals on SMP commitment) and in the evening Fed's Lacker is speaking. An important event this week is the ECB's first 36-month Long Term Refinancing Operation. Banks are expected to use this facility to borrow substantial amounts, which could provide some relief to markets including some peripheral bonds with shorter maturities. Progress or not on a Greek PSI agreement is also a market theme.

Fixed income markets: Last week ended on a strong note for most fixed income markets with both German and US yields heading sharply lower and core European markets performing as well. Uncertainty about the EU policy response and the verdict from rating agencies was behind the move. The EU finance ministers‟ conference call today about the new stability pact and the IMF capital infusion might generate some interesting news. The news about the dead of the North Korean Kim Jong Il is negative for global risk appetite due to fear of following instability in North Korea. Moreover, concerns about the Chinese property market continue to intensify following another drop in the price data. With no clarification from S&P on the rating for France (and hence EFSF) and still too many loose ends in the EU response to the crisis, we think the recent downward move in bond yields in the US, Germany and Denmark could continue in a risk-off environment today. There is no EU bond issuance scheduled for this week.

FX markets: Non-commercial investors added slightly to long dollar positions last week according to the IMM data. Long dollar positions thus remain stretched and near a record high. The build-up in long dollar positions came on the back of further EUR selling and a sharp reduction in long JPY positions. USD/JPY is trading near 78 and investors may be cutting their long exposure due to the recent inability of the yen to strengthen in a risk-off environment. In other words, USD/JPY has not proven a good risk hedge. EUR/USD has been surprisingly stable despite the negative European rating announcement, which is likely to reflect the fact that the market is already very short.