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Guest Commentary: S&P Finally Gets It Right - Euro Set to Fall Further in Early Week

Guest Commentary: S&P Finally Gets It Right - Euro Set to Fall Further in Early Week

Jonathan Granby, Analyst,,

The S&P downgrades which hit nine European nations late on Friday marked a significant departure from recent S&P activities, mostly notably its historic downgrade of the US credit rating back in August. At the time the author wrote that the S&P had adopted a ‘downgrade first, ask questions later’ approach after being rebuked for their mismanagement of ratings ahead of the financial crisis:

“It is our belief that the S&P, and rating agencies generally, have taken up the ‘downgrade first, ask questions later’ motto after their woeful missteps in the run up to the financial crisis. Rating agencies were lambasted for their inability to foresee the balance sheet problems that bankrupt two Wall St banks and cost ordinary citizens billions of dollars and many jobs. The agencies were also criticized for their cozy relationship with the companies with which they were providing coverage and the apparent ‘revolving door’ between the agencies and the corporations. The bottom line is that they did a horrific, possibly even criminal, job ahead of the financial crisis and with their backs against the wall have adopted an equally ridiculous stance of throwing downgrades around like they are chump change.

This new stance has largely only been seen and felt in Europe with multiple downgrades hitting heavily indebted nations like Greece, Ireland, Portugal and Spain. This action has drawn the ire of the ECB and EU officials alike as they believe, like the author, that the rating agencies have adopted an overly ruthless approach. Now that the US has been drawn into this mess criticism of the ratings agencies is likely to rise above the clamour of various European officials and could trigger a breaking up of the monopoly the three major rating agencies have on the industry. The new ‘downgrade first, ask questions later’ outlook was compounded on Friday evening by the massively embarrassing $2 trillion accounting error found by US Treasury officials ahead of the downgrade (it is policy to inform the relevant government ahead of time of a downgrade). While S&P vocally and virulently defends itself and its ultimate decision to downgrade the US’ rating, in spite of the accounting error, for the average commentator the action stinks like something rotten and leaves us with the feeling the S&P were out for their pound of flesh rather than doing their job to the highest possible standard.”

It now appears however, that the S&P have learned their lesson and such reckless actions are in no ones interest, last of all their own. The recent downgrades of nine EMU nations, including Spain, Italy and France were long anticipated by the market after repeated warnings by S&P. S&P time and again outlined the steps they wanted to see from the EMU as well as domestic governments if nations were to keep their ratings. It was only after repeat EU summits and, as S&P called it, a “misdiagnosis” of the euro-zone crisis did the rating agency follow through with its threat of downgrades. It was also prudent enough to issue blanket downgrades that many officials had feared and spared Ireland, Belgium, Estonia, Germany Finland, Holland and Luxembourg. It is not without a sense of irony that these nations were spared the axe of downgrades; after S&P identified the internal imbalances of the euro region as the main problem the rating agency favoured those nations that have managed to run current-account surpluses consistently, a surplus is an imbalance.

In any event the rating agency seems to have finally found some sort of middle-ground to operate in. Without having to overstep its reach and react childishly to criticism, which it is due and should internalise, but manage the ratings of nations and firms correctly. While S&P is certainly righting some of its previous wrongs on the national level it remains to be seen if the same can be done on the domestic level when rating firms with whom rating agencies have something of a revolving door. Rating agencies still have a long way to come and a lot of work to do to ensure that the catastrophic missteps that led up to the financial crisis do not happen again. They need to be reminded time and again of their errors to ensure they redouble their efforts to regulate the industry better in the future but a glimmer of hope has emerged over the weekend that they are finally on the right path.

Meanwhile, the outlook for the euro itself has become increasingly clouded in the aftermath of the downgrades. As a techno-fundamental analyst the outlook in the aftermath of a decent Italian auction and upbeat ECB President Draghi into the end of last week coupled with a double-bottom forming on EUR/USD charts made a sound case to enter a euro long position in anticipation of a move back toward 1.3000. However, the multi-nation downgrades, anticipated as they were, certainly complicates the issue. Most notably, the EFSF is now backed by only four AAA-rated nations, which combined account for less than half of euro-zone GDP; the outlook for EMU bonds is bleak in coming weeks.

As if this wasn’t enough to reverse our previously mentioned position talks between Greece and their private sector creditors over how much losses the private sector creditors should bear broken down on Friday afternoon. If the talks can’t be put back on track early in the week the fear of a messy Greek default may outweigh investor concern over the Friday downgrades. In any event, be the focus on downgrades or the breakdown of talks in Greece we feel relatively confident shelving our aspirations of a bounce in EURUSD toward 1.3000 and refocus ourselves to start looking lower toward the 1.2500 region and 1.2000 below.

Written by Jonathan Granby, Analyst,

Jonathan Granby is an analyst for where he provides coverage of G10 FX.

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