Fitch Strikes Again

Following on the heels of the recent euro area downgrades by S&P, Fitch has now also issued several new downgrades. While this has not been unexpected, it further complicates the efforts to bring the crisis under control. Of course one must always keep in mind that these downgrades are only belated confirmations of what the markets have long ago recognized and priced in already. The only new problems raised by such downgrades come from indexation and the rules governing the fiduciary responsibilities of certain institutional investors. Investors who allocate their bond investments by the weightings that such bonds have in bond indexes are forced to sell bonds that are removed from indexes due to rating changes – this is one of the effects currently plaguing Portugal's bond market.

This in turn then forces clearing firms such as LCH Clearnet to alter the margin respectively haircut requirements of the bonds concerned in repo transactions, if their spread over the benchmark (a mixture of several AAA rated euro area government bonds) increases beyond a certain minimum threshold.

These margin increases in turn then tend to set off a spiral of even lower bond prices, provoking more downgrades and so forth. Italy has just been spared this fate as Clearnet lowered margin requirements on Italian bonds again following their LTRO induced recovery. Alas, Italy is in great danger to re-enter the death spiral if more credit rating downgrades are issued.

Fitch issued five major downgrades on Friday – and Italy and Spain were among them:


“The credit ratings of Italy, Spain and three other euro-area countries were cut by Fitch Ratings, which said the five nations lack financing flexibility in the face of the regional debt crisis.

Italy, the euro area’s third-largest economy, was cut two levels to A- from A+. The rating on Spain was also lowered two notches, to A from AA-. Ratings on Belgium, Slovenia and Cyprus were also reduced, while Ireland’s rating was maintained.

The downgrades, flagged a month ago by Fitch, come as Greece negotiates with creditors on how to avoid a default and other euro nations struggle to bolster the region’s defenses against contagion should those talks fail. While sovereign-bond yields have fallen in Italy, Spain in recent weeks as the European Central Bank added liquidity, the countries downgraded yesterday still lack financial flexibility, Fitch said.

“The divergence in monetary and credit conditions across the euro zone and near-term economic outlook highlight the greater vulnerability” these nations face in the event of financing shocks, Fitch said. “These sovereigns do not, in Fitch’s view, accrue the full benefits of the euro’s reserve- currency status.”

Belgium’s rating was cut to AA from AA+, while that of Cyprus was pared to BBB- from BBB. Slovenia was downgraded to A from AA-. Ireland’s long-term rating was maintained at BBB+.

All the countries were removed from “ratings watch negative,” though they retain a “negative outlook,” which implies the possibility of a downgrade within two years, according to Fitch.”


While Italy and Spain remain the biggest worries for the euro area, one should not forget that Belgium is so to speak part of the 'hard currency core's' weak underbelly. For the moment, the markets are giving Belgium some rope, but this doesn't mean it won't become a focus again at some point in the future.


Credit Market Charts

Below is our customary collection of charts updating the usual suspects: CDS spreads, bond yields, euro basis swaps and a few other charts. Charts and price scales are color coded (readers should keep the different scales in mind when assessing 4-in-1 charts). Prices are as of Friday's close.

On Friday, the markets were still fairly exuberant. This may change at any moment, given the fact that the euro area crisis has merely received a stay of execution by the ECB's latest interventions, so to speak. The summit currently underway and the still stalled Greek debt negotiations are apt to throw a monkey wrench into the happy 'risk on' partying.

On the other hand, a second huge 36 month LTRO exercise is to be put in place in late February, so the markets have to look forward to that as well.

On Friday most CDS spreads and yields continued to retreat, but Portugal's were once again a notable exception. Portugal is now widely regarded as a 'Greece in waiting'. CDS on Portugal's government debt have hit a new all time high of 1,431 basis points on Friday and its 10 year yield landed above 15% for the first time since Portugal joined the euro.



5 year CDS on Portugal, Italy, Greece and Spain – CDS on Portugal hit a new all time high – click chart for better resolution.



5 year CDS on France, Belgium, Ireland and Japan – small bounce in CDS on Japan – click chart for better resolution.



5 year CDS on Bulgaria, Croatia, Hungary and Austria – all still falling – click chart for better resolution.



5 year CDS on Latvia, Lithuania, Slovenia and Slovakia – click chart for better resolution.



5 year CDS on Romania, Poland, Lithuania and Estonia – a few small bounces here – click chart for better resolution.



5 year CDS on Bahrain, Saudi Arabia, Morocco and Turkey – all bouncing a tad on Friday. Bahrain still near its recent highs – click chart for better resolution.



5 year CDS on Germany, the US and the Markit SovX index of CDS on 19 Western European sovereigns – these were all still heading lower on Friday. The SovX seems to be in a corrective formation – so far one can make the case that it is an a-b-c type corrective wave, but it may well become more complex as time goes on – click chart for better resolution.



Three month, one year, three year and five year euro basis swaps – a slight dip on Friday – click chart for better resolution.



Our proprietary unweighted index of 5 year CDS on eight major European banks (BBVA, Banca Monte dei Paschi di Siena, Societe Generale, BNP Paribas, Deutsche Bank, UBS, Intesa Sanpaolo and Unicredito) – approaching another major support level and bouncing a bit on Friday – click chart for better resolution.



5 year CDS on two big Austrian banks, Erstebank and Raiffeisen – a small bounce – click chart for better resolution.



10 year government bond yields of Italy, Greece, Portugal and Spain – except for Spain – yields continued to head lower on Friday, with the exception of Portugal and Greece. Spain's ten year yield is now at an important level of lateral support – click chart for better resolution.



UK gilts, Austria's 10 year government bond yield, Ireland's 9 year government bond yield and the Greek 2 year note – click chart for better resolution.



Portugal's 10 year government bond yield – another new high, closing on Friday above 15% for the first time since Portugal joined the euro – click chart for better resolution.






Charts by: Bloomberg




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