S&P move would make EU stability history

WITH member states coming to the grim realisation that if the Eurozone situation gets any worse they are going to be inflicted with Bob Geldof staging a charity concert for it, the S&P ratings agency drew that nightmare one step closer.

On Monday, the ratings agency put the bulk of the Eurozone on creditwatch negative – meaning a fifty per cent chance of a downgrade over the next three months for 15 member states. S&P said that all of the Eurozone’s remaining AAA-rated sovereigns could be set for a one notch downgrade – Germany, France, Austria, Finland, Holland and Luxembourg. The remaining nine countries were at risk of a two notch cut.

The S&P parotted every other market commentator when it said that: “Systemic stresses in the eurozone have risen in recent weeks to the extent that they now put downward pressure on the credit standing of the currency zone as a whole.” It added that the outcome of the EU leaders’ summit at the end of this week could trigger them to move forward with the threatened downgrades.

This move to put the AAA Eurozone sovereigns under threat also knocked the legs from under the troubled European Financial Stability Facility, and its precarious position was underlined when S&P put its credit rating on the naughty step along with its sovereign underwriters.

This double whammy of announcements took the wind out of any euro strength that might have come out of news of a Merkozy accord that proposes further fiscal integration – putting the full ECB balance sheet on the line against out of control peripheral borrowing costs. “Markets didn’t get the chance to fully price in the announcement, undermined by the S&P announcement,” says Ilya Spivak, currency strategist at FXCM. “This ought not change the landscape however – the EU summit was already of existential importance for the currency bloc before S&P added its two cents.”

The EU summit will take place on December 8 and 9 and is seen by many as do or die time for Eurozone cohesion. As such, it is unlikely that we will see huge activity in euro pairs until the summit kicks off.

Many of the proposals being tabled follow on from Monday’s meeting between German chancellor Angela Merkel and President Nicolas Sarkozy. They include a golden rule for balancing budgets, automatic penalties for states with deficits that surpass 3 per cent and a plan to bring forward the implementation of the European Stability Mechanism (ESM). But while the European core may be willing in spirit, the periphery is weak in body. “Given the fact that an ideological divide between EU members has hampered progress and abilities to contain the euro debt crisis over the last year, it could be folly to believe that a new EU treaty would be a smooth implementation process,” says Joshua Raymond, chief market strategist at City Index. As such, while there will be a euro rally in the run up to the summit, traders should expect this to be short lived, when optimism falls away as the summit descends into the usual stop-gaps and half-measures.

It seems a long time since gold was spoken of as a de-facto reserve currency – a barbarous relic of July. Despite risk aversion driven by the S&P downgrade threats, gold has fallen around the $1,700 area. But while gold has been struggling to make gains, the Swiss franc is still having to be aggressively defended by the Swiss National Bank as haven flows push against the euro-Swiss franc floor that was put under the pair at the beginning of September.

When consumer price index (CPI) figures came in at -0.2 per cent for the month and -0.5 per cent for the year – indicating that franc strength is hurting the domestic economy – nervous traders drove the SFr1.241 level in fear that the central bank would try to push the floor up to SFr1.25.

Any Eurozone shocks may put downside pressure on this pair, but consensus is that the Swiss have deep enough pockets to pay off these attacks on the currency.

As the hype builds up in anticipation of Friday’s summit, look to buy into any rallies in euro pairs. But when it all falls to pieces, be ready to sell on the downturn. And if Bono makes a press statement: run.