London Session: Fitch Ruins the Markets’ Slow Cruise into the Weekend

It’s been a long week in the markets. After the marathon session on Wednesday to hammer out the EU debt deal, people are tired and want the weekend to come quickly. Hence, for most of the morning EUR/USD was stuck in a tight 50 pip range and stocks had slowed almost to a halt.

However, there’s no rest for the wicked. Fitch, the rating agency, set the cat among the pigeons and said that a 50% haircut on Greek debt would be a default event. They also said that the new EFSF would be assigned its top credit rating; however markets ignored that and concentrated on the D-word. Risk came off sharply and EUR/USD made fresh lows of the day around 1.4140 where it has found some support.

While risk was due a breather after yesterday’s stunning rally, the holes in the Eurozone debt rescue deal are starting to attract attention. Prior to the Fitch announcement the euro had brushed off the news of Italy’s debt auction where Rome had to pay the highest ever yield to sell 10-year bonds. As we mentioned in our earlier report, Italy the weakest link in the Eurozone right now. Whereas Spanish, French and even Greek bond yields moderated after the announcement of the EU debt deal, Italy’s 10-year bond yield remains perilously close to 6%.

The initial reaction to the debt deal was jubilation but details like whether or not Greek haircuts equate to a default, thus triggering the pay-out of CDS contracts is absolutely vital for investors as they go about trying to price risk. The CDS market is fairly opaque and the amount of exposure to Greek debt insurance isn’t readily available, so if Fitch does class the debt deal’s plans as a default for Greece then some financial organisations could be on the hook for large insurance pay-outs. There is still EUR 200 bn of Greek bonds outstanding, of course not all of this is insured, but it’s the bit that is that is causing today’s bout of volatility.

Events in Germany are also grabbing the headlines. The German Constitutional Court has halted the use of a special parliamentary committee to decide on changes to the EFSF on behalf of the entire Parliament. The Committee was made up of 9 members from all the political parties; however some politicians felt that it encroached upon their rights as Parliamentarians. Until this problem is resolved the Bundestag cannot take any decisions on the latest EFSF changes. Since Germany is the major contributor to the fund, that decision leaves us in no-man’s land until a formal ruling is agreed…

We need to hear more about whether or not each Eurozone member will need to pass the latest debt deal. It took 3 months to pass the tamer version of the EFSF agreed back in June, so the EUR 1 trillion version could take much longer. This was always the risk with the latest deal, however yesterday it seemed to have slipped the markets’ mind, today it was brought back to the forefront.

There are a few other issues to consider today. US personal income and spending data was roughly in line although core PCE fell in Sept to 1.6% from 1.7% in August. US consumer confidence is released later on, it is expected to move slightly higher to 58.0 after October’s initial reading of 57.5. Also USD/JPY is back towards record lows at 75.75. This makes the risk of intervention today particularly high.