Credit rating agencies disperse fear

illustration: DNB markets dealingroom

(06.07.2011) Fears that the proposed roll over of Greek government debt will be interpreted as default and a downgrade of Portuguese government debt to junk weighed down financial markets yesterday. In the currency market the euro has weakened against safe havens, while pound sterling strengthened.

By Maren Romstad, Analyst at DNB Markets

Stocks ended more or less flat on Tuesday and investors have taken a break from last week’s surge. There are several factors that have put a damper on risk appetite this week, and especially the debt crisis in Europe is increasing the demand for safe havens. Treasury yields fell as a result of higher demand and the euro has depreciated quite significantly against the Swiss franc.

A contributing factor was probably increased fears that the proposed roll over of Greek government debt will be interpreted as default. The concerns probably increased after rumors that several major banks met in France to discuss the proposal yesterday. On the other hand, a key source in the European central bank said that the ECB would continue to accept Greek government bonds as collateral, even though some rating agencies interpret this as default.

Furthermore, new worries that the most severe elements of the European debt crisis could spread intensified yesterday as Portuguese government debt was downgraded to junk by Moody's.

A series of weak macroeconomic data from the euro zone did little to lift the mood. Retail sales fell 1.1 per cent from April to May, which is another proof that budget cuts and the tax and VAT increases weigh on the European consumer. Annual growth fell to its lowest in 18 months. The decline was broad based, with the largest monthly decline in Portugal. This is also one of the countries that have introduced the toughest budget cuts.

Looking further ahead, there are several factors that indicate that consumption will not succeed in taking over as the growth driver, as industrial production and export growth is abating. Unemployment remains high, wage growth is still low, while prices are rising. And with further fiscal tightening in most places, as well as interest rate hikes from the ECB, consumption growth will probably be weak going forward. In addition to the weak consumption figures, the final PMI index for June was even weaker than the pre-estimate. From the peak in February total PMI have fallen five points.
The same tendency has been observed for the corresponding index in the UK. Yesterday's figures (CIPS) for the service sector, however, surprised positively and the market reacted by sending the pound stronger. The index only rose by 0.1 points and was only marginally better than consensus. In addition, the index is below its historical average. Thus, the large movement for pound sterling on the background of yesterday's figures was a bit strange, but this may be an indication that the currency seems undervalued at current levels. Weak macroeconomic data has been one of the main reasons for the record weak pound and the prospect of poor economic growth has made investors negative with respect to the British currency. According to figures from the Chicago Mercantile Exchange speculative players increased their bets against the pound last week.
The Swedish krona strengthened immediately after yesterday's decision to raise rates to 2.00 per cent. This was the seventh interest rate increase in a row from the Swedish central bank. It was probably not the decision itself which benefitted the currency, as it was largely expected. More important was the interest rate path being kept unchanged for the second meeting on a row. The rate path indicates two additional rate hikes this year and a repo rate at 2.50 per cent at year end. We had expected that the rate path could be adjusted somewhat downwards in light of several indicators showing signs of a slowdown.

Consumption figures have disappointed in recent months, production growth and industrial orders show signs of abating and the PMI index is on the way down. These are all reasons why we only expect one interest rate increase from the central bank this year. There was also disagreement in interest committee this time. Both Svensson and Ekholm reserved against raising interest rates and interest rate path.