EUR move Exaggerated?

The market needs an extended break to digest what was dumped on her late Friday and Martin Luther King Day in the US gives us that opportunity. The decision by S&P to downgrade the sovereign ratings of nine euro-zone nations continues to weight on risk sentiment across all asset classes. Thus far, the market believes that the one notch downgrade in France's rating to AA+ should not snowball into widespread selling of French product. That theory has been tested this morning with the French Treasury coming to market with +EUR8.7b of 84-day-357-day T-bills. The issues drew strong investor demand in Frances first bill auction of 2012 with short-term yields rising only slightly from record lows reached in its last auction of 2011.

The biggest fallout from the rating agency's actions will be the potential effect it could have on the EFSF. If the EFSF rating is downgraded, analysts estimate that the lending capacity would be reduced to +EUR150b. The German MoF is “in no doubt that the EFSF can fulfill tasks with the current volume.” The S&P's chop has left Portugal with a rating of BB negative outlook, and has taken the country from a pool of investment grade assets to speculative grade, joining Greece and Cyprus. It seems logical to assume that if Greece cannot pull-off another PSI and move closer to default, then it will only be matter of time before Portugal is on ‘her shoulder.' Policy makers unwilling to commit further funds are going to have a difficult time convincing investors that PSI for Greece will be the last.

Big picture, unless Draghi and company change its tune on QE or Merkel her views on Eurobonds then it will not be long before the market again is talking about another bailout for Portugal and an earlier focus on that country's PSI situation.

FX moves seem to belie sovereign yields at the moment. Despite rates punching above their weight, there is a perception that the EUR has weakened too much following the rating announcements last week. The downgrades do not have much of a surprise element in it and the EUR has still managed to drop 1.5-big figures. In times past, and with FX anticipating a downgrade, the single currency typically weakened -0.3%. Is this currency move exaggerated? Perhaps it is the new norm to be seen across all asset classes?

Again, this morning selling EUR's on rallies is preferred, giving the market a bearish consistency in all asset classes. With the US on holiday and in some corners a perception of an oversold market should lead to some further consolidation in the currency markets short term.

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