Spain Dissed by S&P

Shortly after the North American markets closed, S&P surprised investors by declaring a two-step downgrade of Spain's sovereign rating to BBB-.  This is the lowest investment grade rating.  It is matching Moody's current assessment, but it has indicated it will complete its current review this month.  Many had expected it at the end of Q3.  

Because S&P is playing catch-up rather than leading Spain's sovereign rating, it may not be materially important.  .  However, the timing was surprising.  This week's euro zone finance ministers issued supportive comments about Spain.  Many observers have been talking and writing as if Spain was turning back the financial crisis.   We remain skeptical.

The ink on Spain's 2013 budget is hardly dry and it already lacks the credibility on the grounds that it assumes what nearly every one else regards as an unrealistically optimistic forecast that the economy only contracts by 0.5% next year. S&P noted the downside risks to growth.   

The sovereign downgrade will likely have knock on effects on banks and the regions rating and this may be indicated in the coming days.  S&P maintained a negative outlook and pointed to the friction between the central and local governments caused by the austerity and rising unemployment.  Yet, S&P insists that it will cut the ratings again if support for the current reform agenda wanes.

The S&P move is likely to be seen in Europe, and especially Spain, as a slap in the face.  Spain has recently announced more structural reforms, the ESM is operationalized, the ECB's OMT is in place.  The news initially weighed on the euro in thin pre-Asian activity.  It fell about two-thirds of a cent and found a bid just above Wednesday's lows in Asia, near $1.2840.

Support extends into the $1.2800-25 band.   While the euro's technical tone continues to deteriorate, as we have noted, it may not be quite ready to convincingly break that support, though we advise medium term investors to be prepared for this likelihood.   It now seems to require a move above $1.2930 to stabilize the euro's technical tone.