Morning Market Preview: Irish Bonds Cut By Moody’s, Problems in Hungary

From Brown Brothers Harriman’s Currency Strategy Team

Highlights

US dollar is mostly firmer on the day vs. the majors as risk off trading seems to be on the upswing, losing ground only to CAD and EUR.  The euro made another attempt to breach the 1.30 area after recovering from early selling due to Moody’s downgrade of Ireland (see below).  While the dollar is likely to remain under pressure due to recent technical damage and the weaker US economic outlook, the euro is feeling a little heavy right now.  Indeed, Hungary news (see below) is a reminder that Europe, both Eastern and Western, are likely to continue generating negative news streams.  Big event risk this week is the planned release of the European bank stress tests, and euro upswing is stalling as markets have gotten a bit nervous about what the results will show.  The yen was weaker across the board while Japan markets were closed for holiday, while the Swiss franc was mixed.  EM FX was mostly weaker, with the forint coming under intense pressure due to failed IMF talks ahead of a central bank meeting today (see below).  As we noted last week, we see heightened risks for the weaker EM credits for the time being as risk appetite remains very choppy and has moved into risk off mode.  Only gainers on the day so far vs. USD are CAD, EUR, and RON, while biggest losers vs. USD so far are HUF, KRW, INR, JPY, and ZAR. 

Asian markets were mostly lower, as MSCI Asia fell almost 1% today on carry over from Friday’s US losses.  China and Thailand were the only major regional bourses to buck the trend, with the CSI 300 up 2.5% on the day.  European markets are modestly higher so far today, with Euro Stoxx 50 up 0.8%.  Futures markets are currently pointing to a modest up open for US equity markets.     

US bond market is likely to continue benefiting from safe haven flows amidst weaker US growth signs.  Japan bond market was closed, while European bond markets are mostly lower as 10-year yields in UK, France, and Germany are up 3 bp, 5 bp, and 5 bp, respectively.  Greek 10-year yields are up 19 bp, Portugal up 3 bp, Ireland up 9 bp, Italy down 2 bp, and Spain down 6 bp.     

Currency Markets

Moody’s cut Ireland’s rating one notch to Aa2 with a stable outlook.  This downgrade was not a surprise.  After losing its AAA status from all three agencies early last year, Ireland was downgraded further by all three later in 2009.  It still remains vulnerable to further downgrades as our model rates Ireland as A-/A3/A- vs. actual ratings of AA/Aa2/AA-.  Indeed, the only surprise from Moody’s was that the outlook was put at stable.  Here is our most recent ratings summary for Europe.  1. After the most recent downgrade to A- by S&P, we believe Portugal is correctly rated but is still vulnerable to further moves given the negative outlook that remains in place.  For sure, Moody’s Aa2 and Fitch’s AA- need to be adjusted downward as our model rates Portugal at A-/A3/A- 2. After the downgrades to BB+ by S&P and Ba1 by Moody’s, Greece appears to be correctly rated as our model shows it at BB+/Ba1/BB+.  However, Fitch’s BBB- is vulnerable to a downgrade 3. After losing its AAA status from S&P last year and this year from Fitch, Spain still remains vulnerable to further downgrades.  Our model rates Spain as A+/A1/A+ compared to actual ratings of AA/Aaa/AA+, and there is no way it holds onto its Aaa status from Moody’s in this current environment, especially after that agency put the rating on watch for a downgrade last month 4.  Italy has so far escaped any rating action during this cycle, but is vulnerable as our model puts it at A+/A1/A+ compared to actual ratings of A+/Aa2/AA- 5. Our sovereign ratings model now puts France as a borderline AA+/Aa1 credit, so there is rising risks that France falls below AAA/Aaa in the coming quarters.  Because France is on the borderline, the case for an immediate cut is not compelling but certainly needs to be monitored closely.

Hungarian markets are under pressure after the IMF mission ended its sixth and seventh reviews of the current program with no endorsement of the government’s fiscal stance.  While Hungary does not need the money now (it did not draw on its fourth and fifth reviews), failure to complete the latest reviews brings into doubt the ability to get a new program when this one expires in October.  The IMF stated that “While there is much common ground, a range of issues remain open. The mission will therefore return to Washington, D.C.  The IMF will continue to actively engage with the authorities with a view to bridging remaining differences.”  No dates for further talks were given, and so if you read between the lines, the IMF appears to be taking a tough stand against the new government’s request for fiscal laxity.  Typically, the IMF accentuates the positive but the new government has apparently not given the IMF a lot to hang its hat on right now.  The central bank meets today and is expected to keep rates steady at 5.25%. We had thought that the window for more rate cuts in H2 depended on how the forint was trading, and so there is no way it can cut given recent HUF weakness.  Indeed, if pressure intensifies on the forint, we cannot rule out rate hikes to support the currency in the coming weeks.  Even though we think an IMF deal is likely to eventually emerge, the fact that the IMF remains so unconvinced of Hungary’s intentions will keep markets very, very nervous.  EUR/HUF had a good run last week, but as we have warned, all the negatives have indeed come home to roost.  We remain negative on HUF relative to the rest of EMEA and EM, and last week we went short HUF vs. EUR around 280 for a move back to the late June high of 288 (done!) and then the early June high of 290.50.  After that, there is some congestion around 300 and 310, followed by the 2009 high of 317.22.  Whether we get there depends on how quickly the government can salvage some sort of IMF approval, but the longer talks drag on, the harder it will be to stabilize investor sentiment.

CFTC data shows that for the week ended July 13, speculative bets on a stronger US dollar were overall lower.  Net short euro positions fell to -27,050 from -38,909 previously, Swiss franc positions moved to net long 14,590 from net short -7,455 previously, and sterling net shorts fell to -34,671 from -38,077 previously.  AUD net long positions rose to 23,480 from 7,246 previously, CAD net longs rose to 22,038 from 8,094 previously, and NZD net longs rose to 5,452 from 2,577 previously.  MXN net longs increased to 28,135 from 22,725 previously.  Lastly, yen net longs rose to 47,359 from 37,926 contracts previously, the highest net long since early December.  With the yen stronger since the start of last week, net yen longs should increase in the next weekly report.  On the other hand, the dollar bloc and the peso really took it on the chin as last week wore on and so net longs are likely to fall in the next report.

Upcoming Economic Releases
Europe/EMEA: Hungary central bank meeting scheduled to end at 8:00 EST/12:00 GMT with no change expected.  Americas:  US NAHB housing index for July is due out 10:00 EST/14:00 GMT and is expected at 16 vs. 17 in June.  US housing data have been weaker than expected lately and so the risk here is tilted towards the downside.  Fed’s Duke speaks at 9:00 EST/13:00 GMT.