Danske Daily

S&P downgraded nine euro-area countries including France, Austria, Spain and Italy. The AAA rating of Germany, Finland and the Netherlands was affirmed.

Rumours of the rating verdict triggered negative sentiment on Friday, sending stock indices lower. Stock indices are also trading in negative territory in Asia this morning.

The negotiations on Greek PSI are set to continue this week after having been “paused for reflection on the benefits of a voluntary approach” on Friday.

Focus today will be on the continued negotiations in Greece and the expected followup rating verdicts from S&P on the EFSF and other entities.

Markets Overnight

S&P downgraded nine euro-area countries  last  Friday after US close. France, Austria,  Malta, Slovenia and the Slovak Republic  were downgraded by one notch, while  Italy, Spain, Portugal and Cyprus  were downgraded two notches. The  AAA rating of Germany, Finland, the Netherlands and Luxembourg was affirmed. Belgium, Ireland and Estonia were not downgraded either. The verdict from S&P had been expected since 5 December, when S&P placed 16 euro-area countries on negative watch.More rating verdicts from the S&P are expected in the coming days. Following the move on France and Austria a downgrade of the EFSF seems very likely.

Over the weekend Chancellor Merkel used the S&P move to reinforce that the euro-area leaders must intensify their efforts  to solve the  crisis  She also said  that  “the decision confirms my conviction that we have a long way ahead of us before investor confidence returns”. Regarding the rating of the EFSF Merkel told reporters that “I was never of the opinion that the EFSF necessarily has to be AAA” and “AA+ is also not a bad rating”.

The negotiations on Greek PSI are set to continue this week after having been “paused for reflection on the benefits of a voluntary approach” on Friday. FTreports that the main dispute in the negotiations are what coupon the new bonds should have. According to FT the negotiations will not continue until Wednesday.

Rumours of the rating verdict triggered negative sentiment in the European trade session on Friday and US stock indices traded in negative territory as well. S&P500 ended the session down 0.5%. In Asia stock indices are also trading in negative territory as we enter the week. Nikkei is down by 1.5% and Hang Seng by 1.0% this morning.

US bond yields moved higher on Friday as risk sentiment deteriorated as rumours on the S&P move intensified. The 10-year yields fell 6bp to 1.86%.
In FX markets EUR/USD fell sharply to a session low of 1.2623 Friday. This morning it is trading at around 1.265. The euro also lost versus the Scandi currencies on Friday with moves lower in both EUR/NOK and EUR/SEK.

Global Daily

Focus today:  We have a very light calendar today with ECB’s release of the SMP purchases as the only interesting release. The purchases have been reduced substantially since the introduction of the 3-year LTROs and another low reading is expected. It is more likely that focus today will centre on S&P’s  expected rating verdict on the EFSF and other entities in the coming days. Finally, the Troika is expected to return to Athens to continue the negotiations on the Greek PSI and the second rescue package. A PSI deal is expected to be reached by the end of this week. A key question is whether collective action clauses are to be imposed, hence, whether the leaders are still aiming for a “voluntary” deal that will not trigger CDS contracts.

Fixed income markets:  Today the market will digest the impact of Friday’s rating downgrade of several European countries by S&P. It is the first big thing for the market since the ECB eased collateral requirements and introduced 3Y LTRO. If the markets manage to overcome the downgrades without a big sell-off, it will be a sign that the ECB programmes are robust and really able to short circuit the negative feedback loop in the market. We are hopeful on this, as the rating action should have taken no-one at full surprise and many of the downgraded countries were removed from negative watch. But it will be crucial to watch for renewed signs of stress in the money market, in German asset swap spreads and in the periphery bond markets. We should expect to see some safe-haven flows into AAA countries including US, Germany and the Nordics and some moderate spread widening vs. Germany for the downgraded countries.

FX markets: The euro came under pressure on Friday as the rumours about the French downgrade started to circulate. The euro is still exposed to high event risks and high euro concerns are still likely the next couple of weeks with intense focus on Greece and the rating consequences of the recent downgrades for the EFSF bail-out fund.

However, we would once again point to positioning in the FX market as a supportive factor for  especially EUR/USD. The latest CFTC data from the week that ended  10 January show that bets against the euro surged to a new record high at 155,195 contracts from 138,909 the week before. The market has never been this bearish on EUR/USD before. Hence, the potential for an abrupt short-covering in EUR/USD continues to grow. We will publish updated FX forecasts tomorrow morning, where we will take  into account the latest developments.