Guess Who the S&P Put on Negative Watch? 15 Euro Area Countries!

S&P put the long-term sovereign debt ratings of 15 euro area countries on negative watch - the six AAA countries are among these.

The plan from Merkel and Sarkozy presented yesterday includes automatic sanctions for countries violating the 3% deficit target.  The announcement fuelled a rally in Italian and Spanish government bonds. Italian 10-years yields ended below 6%.

Main focus today is  Timothy F. Geithner’s meetings with  Schäuble, Draghi and
Weidmann ahead of the ECB meeting and the EU summit at the end of the week.

Markets Overnight

S&P put the long-term sovereign debt ratings of 15 euro area countries on negative watch. Germany, France and the four other AAA countries are included. This is the highest number of countries S&P has put on negative watch at one time. S&P wrote in its statement that the move was  "prompted by our belief that systemic stresses in the euro zone have risen in recent weeks to the extent that they now put downward pressure on the credit standing of the euro zone as a whole”. S&P said that  the  ratings on Germany, Finland, the Netherlands, Austria, Belgium and Luxembourg are not likely to be lowered by more than one notch, if at all.  However, it flagged the risk of  a  possible two-notch downgrade for France, according to WSJ.

Merkel and Sarkozy managed to  reach an agreement after their meeting in Paris yesterday. The two leaders announced that they prefer treaty changes endorsed by EU27, but are open to an agreement among the 17 EMU countries. Merkel and Sarkozy agreed on automatic sanctions of violators of the 3% deficit target in the Stability and Growth Pact. In an attempt to restore confidence it was underlined that private sector involvement (PSI) would  be applied to Greece only. Furthermore, the two leaders called for government budget balancing rules to be written into member states constitutions. They also  suggested  moving the implementation of the ESM forward to mid-2012. Merkel and Sarkozy will provide further details in  a letter to President Van Rompuy Wednesday. Sarkozy said a decision on what route to take would be made at the EU summit, while a potential treaty change should be agreed upon by March.

As expected, IMF approved its share of the sixth tranche for Greece (EUR2.2bn).

The positive sentiment from the European trade that was fuelled by the French/German proposal carried over to the US stock markets. However,  reports about S&P’s warning lowered risk appetite during the US session. The S&P 500 ended the session up by 1.0%. The Asian stock markets are trading in negative territory this morning. Nikkei is down by 1.2% and Hang Seng by 1.5%. US bond yields dropped as risk appetite decreased. The 10-year yields are trading at 2.05%. In the FX markets EUR/USD  dropped below 1.34 on the S&P announcement, and is trading around 1.335 this morning.

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Focus today: After Merkel and Sarkozy yesterday gave us a sketch of a possible outcome of the EU summit later this week, focus today will mainly be on US Treasury secretary Geithner’s attempt to commit ECB to a stronger response in connection with his Eurozone tour that kicks off today. Geithner will today have meetings with both ECB  president Draghi and Bundesbank president Weidmann. Later today Geithner will go to Berlin where he is scheduled to meet German  Finance Minister Schäuble. Otherwise we have a thin calendar today. Most interesting will be October  factory orders in Germany which we expect to have recovered slightly following a sharp drop in the previous month. Revised Q3 GDP growth for the eurozone area will also be released today and here the
main news will be the more detailed numbers for Q3 GDP.

Fixed income markets:  Following a major risk rally and significant spread tightening between sovereign bonds in Europe, the cheer was spoiled last night by S&P. The rating agency’s warning that the remaining AAA countries in the euro area could see a downgrade serves as a reminder  of the fragility of the markets, should this week’s EU summit not succeed. With a major risk rally behind us and only a few days to go  before the ECB meeting and the EU summit, we think the market is likely to become more cautious in the coming days.

Today there is supply from Denmark. The Danish Debt Management Office (DMO) will be auctioning DGB 3% Nov'21 and DGB 4.5% Nov'39. As usual, the DMO has not published any information on the amount of bonds being offered.

FX markets: In the FX market the ongoing debt crisis continues to set the agenda. EUR/USD came under pressure yesterday as S&P said it might downgrade the eurozone countries including Germany. This is another blow to the euro and could further undermine confidence and accelerate portfolio flows out of the area. It will benefit primarily the US dollar, but Sterling and the Scandi currencies could attract attention as well. In that respect we expect strong demand at the Danish government bond auction today underlining the strong demand for DKK at the moment.