The European Union fiscal accord reached earlier this month has been roundly declared a disappointment, prompting analysts to declare that there’s little preventing the common currency from setting new 2011 lows.
More speculation that Europe’s most-indebted nations could have their credit ratings cut will likely pressure the euro this coming week, with a slowdown in the euro-zone economy biting further into investor sentiment.
Last week, a threat by Standard & Poor’s Ratings Service ahead of the summit to cut the credit rankings of one or more euro zone governments has weighed heavily on the market, helping send the euro to an 11-month trough of $1.2945. The common currency traded at $1.3043 late Friday in New York, from $1.3385 a week earlier.
Markets have been on a heightened state of alert since Dec. 5, when S&P put 15 of the euro zone’s 17 countries on negative credit watch. Analysts fear that key members of Europe’s triple-A-rated club — including the powerhouse economies of Germany and France — could suffer the same fate as the United States, which S&P stripped of its top-notch rating in August. Most analysts believe Germany is safe, for now. Yet France’s high debt load makes them the most vulnerable to a potential downgrade.
Both countries “already have higher funding costs,” notes Greg Anderson, senior FX strategist at Citigroup. “France’s debt certainly doesn’t trade like it’s triple-A and Germany’s [credit default swaps] don’t either.” Credit default swaps are considered a gauge of a sovereign’s creditworthiness.
On Friday, S&P rival Fitch Ratings raised pressure on the euro zone’s second largest economy when it lowered its outlook on France’s triple-A rating to negative from stable, indicating there’s a chance of slightly greater than 50% the nation could lose its top investment-grade rating over the next two years. Late Friday, Moody’s Investors Service got ahead of both S&P and Fitch when it downgraded Belgium by two notches, to Aa3, citing the deterioration in euro-zone bond markets.
By some measures, France’s ratio of debt to gross domestic product is now at 80%, which some economists see as incompatible with a top-notch rating.
Observers fear that a rating cut would raise borrowing costs across the euro zone at a time when euro-zone countries can least afford it. Spiking bond yields could worsen the bloc’s deepening economic downturn, heighten already-high anxiety of a sovereign default, and in the worst-case scenario, spell an end to the euro itself.
Triple-A status is especially important for France because it “is vital to the whole European situation staying on course,” said Jason Ware, market strategist at Albion Financial Group.
Along with Germany, France makes up a large part of the fiscal guarantees that backstop the European Financial Stability Facility. The EFSF, the euro zone’s special bailout vehicle, depends on those guarantees to sustain its own triple-A rating, with which it raises money to funnel emergency loans to cash-strapped sovereigns.
The debt and rating outlook is weakened by the fragile state of the euro zone’s economy. Next week, economists expect Germany’s Ifo business index to show more deterioration in the bloc’s largest economy, which raises the chances that Europe could slide into recession.
In the face of this deteriorating situation, recent cuts in borrowing costs and emergency liquidity measures from the European Central Bank are seen as the only factors keeping financial bedlam from breaking out in the 17-nation currency bloc.
This week, the ECB will open the first of two new long-term refinancing operations in an auction aimed at cash-strapped euro zone banks. The three-year financing offering will be closely watched for how much demand it attracts.
In theory, it could relieve the central bank of having to make continued forays into distressed bond markets as banks will be asked to use the proceeds to take on sovereign bonds. It also could help put a floor under the wobbly euro. However, analysts say continued concerns about Italian and Spanish solvency, combined with downgrade fears dogging both countries, are making banks reluctant to supplement the ECB’s emergency bond-buying with their own much-needed cash.
EasyForexNews Research Team