Expectations were engineered ahead of the event so that the outcome was not a disappointment to markets. From that point of view, the EU summit was a success. There was agreement to enact the appropriate treaty amendment to allow the mechanism to be set up from the end of 2013. There was no mention of E-Bonds (common euro-zone bonds) or raising the ceiling on the current ‘bailout’ fund. The detail on the permanent facility will be hashed out next year. Whilst the summit was a success in expectations management, it was a failure in terms of facing the real issues that the EU must tackle between now and 2013 and most likely in 2011. Haircuts on senior bank debt remain inevitable in our view if the required sovereign fiscal adjustment is to be achieved. Furthermore, unless the EU realises that some form of formalised fiscal union is inevitable, the exit route from this crises will remain blocked.
Ireland downgraded. No massive surprise with Moody’s downgrade by 5 notches to Baa1, even though this is a major move in terms of ratings downgrades. Just 20 months ago, Ireland was top credit rated. The new rating is three notches above the barrier between investment grade and non-investment grade debt (or ‘junk’). The outlook also remains negative. Markets have not reacted in any substantial way to this move.
Another lifetime low in EUR-CHF. Early European trading seeing EUR-CHF push another lifetime low at the 1.2721 level. This was on the back of the initial knee-jerk reaction to the EU summit announcement. USD-CHF is also near to the lows for the year, currently around the 0.9600 level, with the year lows around the 0.9463 area. The Swissie is now nearly 13% higher on a trade-weighted basis during 2010, resulting in some slightly more concerned words from the SNB earlier in the week, but at present, they seem some way from become outwardly concerned with deflation risks and also the level of the CHF.
Bank of England. The Financial Stability report is a publication gaining more recognition as the Bank moves to take a greater role in macro-prudential supervision. Interesting to see the latest one warning of the risks from a ’94 style bond sell-off. US yields increased some 250bp during that year, on the back of the start of the Fed tightening cycle. That is not likely to be the trigger this time around, although the bigger concerns from the Bank’s view is the impact on an already fragile banking sector, especially when regulatory changes are requiring them to hold more sovereign debt. We would see a bond-market sell-off as being one of the bigger risks for the coming year, something which would likely be dollar negative should the US debt situation prove to be the catalyst.