Waiting on the Irish Four-Year Plan

Highlights
The US dollar is mostly lower, giving back most of yesterday’s gains versus the dollar bloc but still up versus the euro amid concerns over the European financial crisis. The euro suffered against a backdrop of protracted euro zone debt concerns with frenetic selling driving down to its two-month lows of $1.3284 followed by a strong bounce after rumors of an emergency ECB meeting.  Sterling continued trade heavy but found support following stable Q3 GDP report, leaving sterling around $1.578.  The yen is down as well as the 10-year interest spread favors long dollars by 3bp.  Elsewhere, the tepid recovery in risk appetite has led to a moderate recovery of the dollar bloc, with the Australian dollar testing $0.98 with the Canadian and Kiwi dollars both higher on the day. 

Global equity markets continued to trade heavy but pared some of their losses following a weak session in North America in the aftermath of the North Korea’s shell attacks and the eurozone’s continued fiscal woes.  The MSCI Asia Pacific index is down 0.7% with the Nikkei down 0.8%, led by losses in technology, after yesterday’s holiday.  The Shanghai Composite is up 1.1% with a sharp rise in health care of 4.2%.  In Europe, stocks were mostly up with the Euro Stoxx 600 up 0.4% as the market found was buoyed by the much stronger-than-expected German confidence figures, although Irish financials continue to contract down 25% on the day.  Meanwhile, the FTSE and DAX were both up more than 0.5% led by consumers. 

European sovereign bonds yields continued to increase with the Irish 10-year yield up 25bp while at the same time Portugal’s 10-year yield is up 17bp. The continued weakness in the periphery yields may have been exacerbated yesterday as Irish debt rating was lowered two steps by Standard & Poor’s, citing the need for further government borrowing to fund capital injections into its troubled banking system.  S&P lowered Ireland’s LT sovereign rating to A from AA- and the ST to A-1 from A-1+ and put the rating on CreditWatch with a negative outlook, reflecting the risk of a further downgrade if a EU-led rescue fails to stanch capital flight.  At the same time, 10-year Greek yields were up 14bp slightly ahead of Spain with a 12bp increase.   Additionally, Germany held a very disappointing auction where it sold €4.76bln of 10-year Bunds with a coupon of 2.5% yet the bids did not cover the full amount on offer.

Currency Markets

Ireland’s credit rating was cut two notches by Standard & Poor’s to A, and the agency kept the negative outlook.  S&P cited the ‘troubled banking system’ which would lead the Irish government to borrow more than previously expected, and added that the negative outlook reflects the risks that an EU-led bailout fails to stop investor flows out of Irish assets. Given how jumpy markets are this week it was no surprise that one of the rating agencies took their usual approach and threw some gasoline on the fire with a downgrade announcement.  Irish 10-year yields are up 22 bps so far today and has dragged the rest of the peripheral yields higher as well.  The move was no surprise since our sovereign rating model puts implied Ireland ratings at BBB/Baa2/BBB vs. A/Aa2/A+ actual, and so the negative outlook is warranted.

Moody’s remains way out of line and has also warned of multiple notch downgrades this week.  We continue to be concerned about contagion risks in the peripheral euro zone.  Rumors of a Portugal downgrade made the rounds yesterday, and we fully expect multiple downgrades there too given that our model rates it as A-/A3/A- implied compared to actual ratings of A-/A1/AA-.  Our model also points to downgrades for Spain (A+/A1/A+ implied vs. AA/Aa1/AA+ actual) and Greece (BB/Ba2/BB implied vs. BB+/Ba1/BBB- actual). The euro has continued to soften vs. the dollar, sinking below $1.33 before seeing a slight bounce.  Still, yesterday’s break of the $1.3450-60 area (50% retracement level of the big September-November rise) set up today’s test of the 62% level around $1.3270, break of which would target the September lows around $1.2640.

S&P said that it may upgrade Brazil due in part to strong growth and a well capitalized banking sector.  This underscores one of the many fundamental divergences between the developed and emerging markets, which we expect to continue in 2011.  S&P noted that one major negative factor is the heavy load of government debt.  While we agree that Brazil is due for an upgrade, we believe the rating agencies will wait until Rousseff’s economic team is in place and her fiscal stance is better known.  Our model rates Brazil at BBB/Baa2/BBB vs. BBB-/Baa3/BBB- actual, and so the positive comments by S&P are warranted.  Note rumors made the rounds yesterday that central bank chief Meirelles will be replaced by central bank director of financial regulation Tombini.  While Tombini has a solid background, the shift would still give the appearance that Rousseff wants to exert more control on monetary policy.  Rates need to go up, not down, and so a showdown with the markets may be brewing.

The German November Ifo index unexpectedly jumped to 109.3. The market had expected a marginal increase to 107 while the October figures were revised up to 107.7 from 107.6.  The better-than-expected PMIs and ZEW readings already suggested that the Ifo may surprise on the upside. It is very encouraging that the improvement was due to improvements not only in the current conditions indicator, but also the future expectations index.  But for the second day good economic data continues to be overshadowed by the developments in Ireland.

Upcoming Economic Releases

At 08:30 EST / 12:30 GMT the US reports a bevy of economic reports ahead of the Thanksgiving holiday.  For one, October durable goods orders are expected to drop to 0.1% from 3.3%.  At the same time personal income and spending are expected to increase to 0.4% and 0.5% from -0.1% and 0.2%.  The m/m reading of PCE is expected to remain flat at zero while the y/y figure is expected to fall to 1.0% from 1.2%.   The consensus for initial jobless claims is for a marginal drop to 435k from 439k and the UoM confidence survey is expected to increase slightly to 69.5 from 69.3.  And finally October’s new home sales are expected to increase to 312k from 307k in September. Mexico reports bi-weekly CPI at 10:00 EST / 14:00 GMT.  Events: The Irish four-year plan is to be published at 10:00 EST / 14:00 GMT, which will include details on €15bln in savings.