WISE MONEY

The ratings agency Standard & Poor’s left the growing mood of optimism about the eurozone debt crisis in ruins last night by warning the wise money markets that 15 of the regions 17 countries face credit downgrades if politicians do not gain control of their economies. S&P blasted Brussels “defensive” management of the crisis blaming the prolonged dispute among European policymakers for destroying investor confidence.

All of the AAA rated sovereigns which includes Germany and France have been placed on “negative credit watch”.

S&P highlighted that the French banks were a particular worry as the amount of external debt has risen above France’s GDP.

The timing could hardly have been worse as German Chancellor Angela Merkel and French President Nicolas Sarkozy sent investor sentiment soaring earlier.

Their united front had led to a significant drop in the borrowing costs for many of the struggling Eurozone nations including Italy, whose 10 year yields dropped below 6%.

The other announcements due out this week have been made rather insignificant though the central bank meetings due out on Thursday will maintain some weight in the markets.

The Bank of England will keep their base rate on hold at 0.5%, but any comments from the MPC Committee will be looked into.

The ECB will reveal their decision 45 minutes later and they are expected to cut their rate back to the 1% it was reduced to during the height of the credit crunch.

If this is the case, it will show a remarkable turnaround in the fortunes for the eurozone as the interest rates seemed to be on an upward curve in the 2nd quarter of this year.

The under fire Greek Prime Minster George Papandreou sensationally performed a u-turn yesterday by cancelling his controversial idea of a referendum into whether the Greece should accept the latest bailout package. This has left the Greek government on the brink of collapse as infighting has led to the PM losing his majority.

The political skirmishes spread to the latest G20 summit in Cannes where numerous politicians have balked at the idea of putting up more cash to support the ailing Eurozone economies through the IMF.

The main discussion of the summit is whether to double the size of the International Monetary Fund.

Prime Minster David Cameron has maintained his view that it was in Britain’s economic interest to offer to underwrite billions of pounds in IMF loans.

Even if Greece can avoid default through its current bailout and the support of a beefed-up IMF, world leaders have for the first time spoken about the possibility of Greece exiting the Euro.

French President Nicolas Sarkozy said it was up to the Greek people to decide their future- through his clenched teeth.

The other big announcement yesterday came in the shape of the latest ECB rate decision.

New President Mario Draghi surprised the markets by cutting the base rate from 1.5% to 1.25% in a bold move looking to increase growth across Europe.

In the subsequent press conference, the new president discussed inflation in the Eurozone stating that it is currently over 3%, but will fall below the target level of 2% in 2012.

At least one more cut is predicted over the months ahead as the ECB continues to battle a rapidly worsening economic outlook.

Eurozone finance ministers are meeting to discuss the region’s debt crisis in the first of several summits to be held in Brussels over the weekend.On Saturday, ministers from all 27 EU countries will hold talks. EU leaders will then gather on Sunday and at an extra meeting on Wednesday.

They need to agree a second bailout for Greece, how to recapitalise banks, and a stronger bailout fund, before Greece can then be allowed to default- and there still appear to be deep divides between France and Germany.

In particular, the two need to agree on how to increase the firepower of the eurozone’s bailout fund, the European Financial Stability Facility (EFSF), from its current 440billion euros ( £383 billion).

France has proposed turning the EFSF into a bank so that it could borrow from the European Central Bank (ECB), but Germany has refused to sanction such a move, arguing it would compromise the ECB’s impartiality.

The German government has also promised its taxpayers that its contribution will not go above 211bn euros so is looking for a way to increase the size of the fund without increasing the liabilities of German taxpayers.

Despite no apparent movement on the deadlock, markets were trading higher, with the leading indexes in London, Frankfurt and Berlin all up between 1.5% and 2.7%, while US markets also rose at the start.

Jean-Claude Juncker, the chairman of the eurogroup and the prime minister of Luxembourg, said the delay to a deal portrayed a “disastrous” image of the eurozone to the rest of the world, adding that it was not necessarily just France and Germany that had differences of opinion.

This crisis has underlined that the EU, in large part, remains a Franco-German union. The other members of the eurozone appear as bystanders whilst the French and German leaders determine the fate of their currency.

A deal on the euro had been expected to be signed on Sunday, but France and Germany said they would not be able to reach an agreement by then and announced that leaders would meet again on Wednesday.

Sunday’s summit had already been delayed from 17-18 October because more time was needed to finalise a plan.

A second hurdle in the way of any rescue plan is that negotiations have not yet begun properly with private sector lenders to Greece on a further reduction of what the Greek government will repay them.

Banks have already agreed to take a 21% loss, or “haircut”, on their loans to Greece but there is growing pressure for them to accept higher losses.

Previous disagreements between France and Germany about the bailout plans have centred on how much the private sector would have to contribute to any package.

Things seem, for once, to be moving quickly in the eurozone. After high drama in Slovakia over ratification of the enlarged bail-out fund last week, this week looks set to be all about leverage.

More specifically, it will be about how the eurozone makes sure the EFSF has enough fire power to assure the markets that if things begin to unravel, Spain and Italy will be able secure funding without leaving the cupboard bare.

The plan gaining most traction was proposed by Allianz and involves the EFSF guaranteeing the first wave of losses on Greek, Portuguese and Irish bonds.

This would see the funds boosted to around €3 trillion.

Sounds good in theory doesn’t it? Except the structure looks eerily similar to the instruments at the heart of the sub-prime meltdown – collateralised debt obligations or CDO’s for short.

The CDO’s were supposed to spread risk around the system making it safer overall.

What they did, along with industrial scale securitisation was disconnect the borrower from the lender, mask the risks behind complex mathematical formulas and in turn removed all due diligence procedures about the credit worthiness of the borrower.

The risk with the EFSF insuring debt is that if we move back into a serious recession and other eurozone countries look to default because it is suddenly easier to do so, all the losses will simply have been moved from lots of smaller place to one huge pot.

Despite the worries over the structure of the newly enlarged bail-out funds, euro sentiment continues to improve and lift the Euro against both the Dollar and Sterling.

The president of the European Council has said that a summit of EU leaders to discuss the eurozone debt crisis has been delayed by a week.Herman Van Rompuy said more time was needed to finalise a plan to give money to Greece and bolster debt laden banks.

The summit, originally planned for next Monday and Tuesday, will now start a week later on 23 October.

European regulators and the leaders of Germany and France have been engaged in intense talks for several days.

Mr Van Rompuy said in a statement that the delay will allow the EU “to finalise our comprehensive strategy on the euro area sovereign debt crisis covering a number of interrelated issues.”

The 27 nation EU, and in particular the 17 country eurozone members have found themselves under growing market pressure to finally act.

Fears that Greece and other highly indebted countries will default on their debts, and cripple the banks that hold their bonds, have sent shockwaves through financial markets.

On Sunday, German Chancellor Angela Merkel and French President Nicolas Sarkozy said they were close to agreeing a comprehensive new package to ease the eurozone’s debt crisis. However, they gave no details.

Mr Van Rompuy also said he had asked for an additional meeting of EU finance ministers ahead of the 23 October summit, so they can lay the groundwork for the leaders’ decision.

Thursday will be the tale of two central banks.The Bank of England’s MPC finish their two day meeting today with growth, or the lack of it, the main point being debated.

With interest rates still at historical lows, further quantitative easing will almost certainly be on the agenda.

Remember, at the last meeting none of the MPC voted for a rate increase, this is down from three members a couple of months ago (although one of them, Andrew Sentence has subsequently left).

The voting preference at last time suggests worries over a stalling economy is increasingly dominating the rate setting meetings.

Sterling has remained under pressure after the three cent move against the Dollar on Tuesday stemming from the SNB intervention to stop the appreciation of the Franc.

The safe haven status of the Swissy has been checked somewhat by the intervention and the USD dollar has benefitted enormously from inflows.

We expect the market to test the resolve of the SNB at the 1.20 level over the coming days, which should lift Sterling but we keep around the 1.59 – 1.13 levels against both the USD and Euro for a lengthy period until the market is either satisfied that the SNB is serious about maintaining the peg or attempts to take on the bank and push the CHF back towards 1.10.

The ECB, in comparison to the BOE, does have room to cut interest rates and it is likely that they are considering doing so over the course of the next few months.

The betting was for another rise before the start of New Year, which is surely off the table given the deterioration in the world economy over the previous month.

The situation is complicated slightly by the arrival of a new ECB head before Christmas, who may want to gain a hawkish reputation early and do this by holding rates steady more than the market is forecasting, but the change in bias has definitely shifted from rate hikes to more of a wait and see which should translate into a slightly weaker Euro moving forward.

Following the carnage from both sides of the Pond last week, the money markets will aim for some form of restoration and degree of normality in the early sessions of trading this week.  This could prove difficult, following continued worries about global economic growth, concerns over the eurozone debt crisis and finally late on Friday the downgrade of the US sovereign credit.

This all comes at a time when many top policy makers are on vacation and market liquidity is thin during the summer holiday period.

It was hardly a huge surprise when the US lost its top AAA rating last week.

S&P had been warning the US for several months about a possible downgrade and when the smaller than hoped for $2.1 trillion cuts in the US fiscal deficit were announced, this left the rating agency little choice.

Some consolation will be taken from the fact that the other two main ratings agencies Moody’s and Fitch have so far maintained the top tier rating for the US, although Fitch will be reviewing this before the end of the month.

Inevitably comparisons to 2008 are being made, however there is fundamental difference this time around.

While in 2008 policy makers were able to turn on the financial and monetary taps, the financial clout of governments is now in question.

There is little room for manoeuvre on government spending in western economies as this has now been totally used up, while interest rates are already at an all time low.

One could argue the US Federal Reserve can embark on another round of asset purchases but the effectiveness of more QE is very limited.

Confidence is pretty low right now so what light if any is at the end of tunnel?

EU officials had hoped that their agreement to provide a second bailout for Greece and beef up the EFSF bailout fund would have stemmed the bleeding but given the failure to prevent the spreading of contagion to Italy and Spain it is difficult to see what else they can do to stem the crisis.

One could compare the EU attempts to sticking a plaster on a fatal wound.

Although it is unlikely that the eurozone will disintegrate (more for political rather than economic reasons) there may have to be sizeable fiscal transfers from the richer countries to the more highly indebted eurozone countries otherwise the whole of the region could fall down the plug hole.

A Eurozone debts deal appears as though the EU ministers’ main concern was to come up with something, anything, that would settle the markets and effectively ring-fence Greece so that contagion of debt concerns did not occur.The summit therefore did not disappoint with an agreed Euro 109 billion bailout emerging for Greece and statements that the European Financial Stability Fund would potentially be able to purchase sovereign debt in the secondary market and also have the ability to recapitalise Eurozone banks should the need arise.

In addition, private sector involvement in the bail-out was agreed with banks offering Greece longer maturities at improved rates on existing debt, to the tune of up to Euro 50 billion.

All very nice, although it is still not really clear how the latter is going to work and probably more important, how these changes will be viewed by the ratings agencies.

Wise Money feels that the EU hierarchy has already privately accepted that some degree of selective default will be forthcoming – the severity of default assessment will be all-important.

So, is the agreement the first steps in a long term solution that will establish a new Eurozone authority which will encompass fiscal consolidation and system wide risk management – I wonder if they will call it Bundesbank? – or will it emerge that it is just one huge sugar fix for the market.

Certainly, early reaction is just that.

The Euro surges, peripheral Eurozone bond yield crash and equity prices rise… All is rosy in the garden again, but the situation could turn again very quickly if analysis and expectation takes a turn for the worse.

Let’s wait for Moody’s, S&P and Fitch over the next few days.

It was a turbulent day for markets yesterday, as they ponder over the escalating European debt crisis and the evident failure to reach agreement on raising the US debt ceiling. As it stands Europe’s crisis looks to be going from bad to worse, as suggested in the record breaking higher costs of French, Italian and Greek debt yesterday.

The situation reached breaking point as Italy suspended trading on government and corporate bonds following last weeks release of EU stress tests.

The panic led to billions wiped off the value of European banks with the UK alone losing £6.3bln with Lloyds falling 7.5%, with RBS and Barclays losing 6% and 3.7% respectively.

Despite Italy grabbing the headlines attention is still very much focussed on Greece and reaching agreement on a second bailout for the country, with further discussions at the special EU summit on Thursday.

The hot issue remains the extent of private sector participation in any debt restructuring.

The assessment to improve the flexibility of the EFSF bailout fund to embark on debt buybacks has not helped.

As a result contagion risks to other countries in the Eurozone periphery are at a heightened state.

In spite of this the EUR has shown a degree of resilience, having failed to sustain its recent drop below 1.40 versus USD and currently trades at 1.4156.

A possible reason for the EUR’s bounce is that the situation on the other side of the pond does not look much better.

Murmurs of QE3 in the US and the stalemate between Republicans and Democrats on budget deficit cutting measures tied to any increase in the debt ceiling are limiting the Greenback’s ability to profit from Europe’s distress.

Furthermore, more weak data including a drop in the Empire manufacturing survey and a drop in the Michigan consumer sentiment index to a two-year low, have added to the worries about US recovery prospects.

On Friday wise money saw the release of the widely anticipated results of European banking stress tests. All the UK banks passed, with RBS posting the lowest Core Tier One ratio under the so-called adverse scenario.

8 of 90 banks failed the tests, which was around the number estimated before the results were announced but rather worryingly a further 18 barely scraped through.

We expected volatile Euro trading this morning on the back of the uncertainly that the stress tests provided and that is exactly the case.

The Euro was off over a cent early in the session but has regained ground over the last hour.

The main criticism of the tests is the lack of clarity that the models reveal about the institutions being modelled.

The tests did not allow for a default by any of the bailed-out nations (although they would have been run behind the scenes) and many in the market believe getting the information out in the open would be better for the banks in the long term.

Th US Dollar movement is almost all political at the moment.

The trinity of Europe debt worries, the impeding debt ceiling hike (or not if certain republicans get their way) and trying to second guess the Fed over QE3 is meaning we are experiencing huge movements in the Dollar as new information on each is revealed.

Unfortunately we are no clearer to a resolution in any of the main drivers of the USD and we can expect volatile trading to continue.

A US default would be catastrophic, but there is a real possibility that it could happen so USD buyers and sellers should keep a close eye on the rate and consider hedging their bets if this continues.