Peripheral Euro Zone Remains Under Pressure
by Win Thin
We continue to be concerned about contagion risks in the peripheral euro zone. The package for Ireland has ultimately been shrugged off by the markets this week after initial gains in the euro and peripheral bond prices. Ireland 10-year yield is up 27 bp on the day, Greece 10-year yield is up 6 bp, Portugal up 20 bp, and Spain up 11 bp. Greece CDS prices are making new record highs around 1041 bp, as is Spain at around 294 bp. Rumors of a Portugal downgrade made the rounds earlier today, and we fully expect multiple downgrades given that our sovereign rating model rates it at A-/A3/A- compared to actual ratings of A-/A1/AA-. Indeed, given that markets are extremely jumpy today due to euro zone pressures and Korean tensions, it would be the perfect opportunity for the rating agencies to take their usual approach and throw some gasoline on the fire with a downgrade announcement. Besides Portugal, our model points to downgrades for Spain (A+/A1/A+ implied vs. AA/Aa1/AA+ actual), Ireland (BBB/Baa2/BBB implied vs. AA-/Aa2/A+ actual), and Greece (BB/Ba2/BB implied vs. BB+/Ba1/BBB- actual) too.
Euro remains under pressure and today broke the mid-November lows for EUR/USD around 1.3450-60. That area also happens to be the 50% retracement level of the big September-November rise and so the break targets the 62% level around 1.3270. EM currencies and commodities are largely down on the day, as risk appetite remains subdued due to a combination of developments in the peripheral euro zone as well as tensions on the Korean peninsula. Risk off trading has continued to favor the dollar, Swiss franc, and the yen today at the expense of the Scandis and the antipodeans in the G10 space. In the EM space, EMEA currencies are the worst performers on the day, with PLN, HUF, RON, and TRY at the bottom of the heap vs. USD. We continue to favor risk off trading for the time being and look for further weakness in the euro and EM currencies.