More Thoughts On Ireland And Peripheral Euro Zone

by Win Thin

Here are some more thoughts regarding the negative Ireland comments by Moody’s that we highlighted in our daily.  The agency warned of “multi-notch” downgrades to its Aa2 rating, noting that the aid plan will “crystallize more bank-contingent liabilities on the government balance sheet, and increase the Irish sovereign’s debt burden.”  It noted that developments have worsened since the rating was first put on review for possible downgrade back in October.  However, Moody’s predicted that it would remain at investment grade.  Our own sovereign ratings model (newest update due out soon) now puts Ireland at BBB/Baa/BBB vs. actual ratings of AA-/Aa2/A.  Clearly, multi-notch downgrades for Ireland are warranted by all three agencies, though we agree that for now, investment grade (BBB-/Baa3/BBB- or higher) rating should be retained for the country.  We continue to see downgrade risks ahead for Spain, Greece, and Portugal too.  

News of a package for Ireland has ultimately been shrugged off by the markets today after initial gains in the euro and peripheral bond prices.  Ireland 10-year yield is down 4 bp on the day, but has given up most of its earlier gains.  Contagion remains in play too, as Greece 10-year yields are up 31 bp on the day, Portugal up 5 bp, and Spain up 3 bp.  Greece CDS prices are trading right around the record highs from earlier this year.  It seems that the honeymoon for the periphery may end up even shorter than it was after the Greece package back in May, as markets are already turning their focus elsewhere, especially Portugal and Spain.  Political uncertainty in Ireland has risen, as the Green Party said it will support the government until passage of the aid package and the 2011 budget but would pull out of the ruling coalition afterwards, which means general elections are likely in early 2011.  

Euro rally ran out of steam around 1.3790, which is right about at the minimal 38% retracement of the November drop in EUR/USD.  If negative sentiment on the periphery continues, than we would expect a retest of the November lows for EUR/USD around 1.3460, which happens to be the 50% retracement level of the big September-November rise.  Break would target the 62% level around 1.3270.  EM currencies and commodities are largely down on the day, as risk appetite remains subdued.