THE TAKEAWAY: S&P downgrades EFSF from AAA to AA+ > Move largely priced in following wave of sovereign downgrades on Friday > EUR lower, but declines limited

SP_Downgrades_EFSF_in_Widely_Expected_Move_Euro_Dips_Temporarily_body_Picture_5.png, S&P Downgrades EFSF in Widely Expected Move; Euro Dips Temporarily

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The Euro weakened after Standard & Poor’s, in a widely anticipated move, downgraded the European Financial Stability Facility one notch from AAA to AA+, with the outlook moved to “developing” from “watch negative”. The action follows the agency’s downgrade of nine Eurozone countries on Friday, which stripped both France and Austria of their top ratings. Minutes following the announcement, the common currency weakened from about 1.2675 to 1.2659 against the Greenback, but quickly recovered ground.

Markets had already been speculating that the top rating of the Eurozone’s temporary bailout fund would be under jeopardy following S&P’s downgrades last week. This stems primarily from the central premise underlying the EFSF; underpinning the facility are guarantees from Eurozone members amounting to 780 billion Euros. However, in order to preserve its top rating, the facility’s effective capacity was limited to 440 billion Euros – or the portion guaranteed by the Eurozone’s AAA-rated members. With the downgrade of France – which had guarantees amounting to close to 160 billion Euros – the facility would be unable to rating its triple-A while remaining at its current capacity in the absence of additional guarantees.

All eyes are now on the talks between the IIF and the Greek government on the terms of a voluntary haircut on the country’s debt and the EU leaders’ summit on Jan. 30, where details of a fiscal pact will be discussed.