Although stock markets registered gains the rally in risk assets stumbled, with sentiment knocked by news that S&P ratings has placed 15 Eurozone countries on negative watch for a possible downgrade due to “systemic stresses”. Among the 15 were Germany and France. Weaker economic news in the form of service sector purchasing managers indices in China and the US also dented market sentiment.
The Eurozone countries including all six triple A rated governments have a one in two chance of a downgrade within 90 days. Although there has been speculation of a French downgrade the major surprise was the inclusion of Germany in the list. A downgrade of Eurozone countries would hit the ability of the EFSF bailout fund to finance rescue packages for countries give that it is supported by sovereign guarantees from the six AAA rated countries.
Ironically the S&P announcement followed news that German Chancellor Merkel and French President Sarkozy have agreed on treaty changes revealing some progress ahead of the Eurozone summit on 8/9th December. Among the details of the agreement private sector bond holders will not be asked to bear any losses on any future debt restructuring, automatic sanctions for countries that breach the 3% deficit / GDP rule, a “golden rule” on balanced budgets, and an earlier data for the launch of the European Stability Mechanism to 2012.
The “fiscal compact” will be welcomed by the European Central Bank (ECB), with hints by President Draghi that it could be followed by stronger action from the central bank. Although S&P spoiled the party somewhat overnight, markets will go into the EU Summit with high expectations, suggesting that risk assets will find some degree of support. EUR slipped on the S&P news but further losses will be limited ahead of the EU Summit, with markets looking for further concrete actions from Eurozone leaders. EUR/USD will be supported around 1.3260 in the short term.