The downgrade of France and other European countries may have been anticipated for some time but since there is every risk that further negative credit ratings news could follow, there is next to no prospect of relief for the markets at this juncture. 

For France and a bunch of other countries that are on negative outlook, there is a 1 in 3 chance that another downgrade could be announced over the next couple of years.  

S&P has warned that for France another notch in its credit rating could be triggered by a further deterioration in its fiscal situation.  Recession and an already relatively high debt stock clearly increase a country’s vulnerability to another downgrade.  In view of the possibility that the Eurozone is currently already in recession and given that there are concerns that the periphery could need even more support, speculation that the Eurozone could be facing further bad news on credit ratings potentially later this year is unlikely to go away.  

The market is also switching its focus to the implications of Friday’s credit ratings news for the EFSF.  The downgrades mean automatic reductions for the lending capacity of the EFSF. German Finance Minister Schaeuble has retorted this morning with remarks that Germany’s guarantee of EUR 211 bln for the fund “is sufficient by far for what the EFSF has to do in the coming months”.  In the current environment, however, the market is unlikely to be reassured. Recessionary conditions mean that all countries in the Eurozone will have increased difficulty in achieving tough budget deficit reduction targets this year. 

While the Merkozy meetings at the start of this month acknowledged the need to support growth this year, Merkel continues to crack the austerity whip. Greece, however, is having clear difficulty in meeting the fiscal expectations of the EC. Greater Greek debt write-offs are on the table and speculation is emerging that in recessionary conditions other peripheral countries may be persuaded to also seek either additional support or perhaps even some debt forgiveness.  Despite the poor outlook short-covering has lifted EUR/USD from the European open this morning. That said we expect conditions in the Eurozone to remains tense this week and continue view rallies as selling opportunities targeting a move lower to EUR/USD1.2500 this quarter.


source: Rabobank