S&P Downgrades Again, But Do Confused Markets Care Anymore?

Italy is the latest to feel the wrath of the credit ratings agencies, as Standard & Poor's moved to downgrade Italian bonds. Once again, the market barely noticed, and many have started to assert that the ratings agencies have become next to irrelevant when it comes to these big country bonds.

It comes as no shock to investors that Italy has issues, and the downgrade didn’t add any relevant information to the mix. The Italians are right there with the other struggling PIIGS nations (Portugal, Ireland, Greece, Spain) in Europe as they watch the yields on their bonds rise. Italy is now looking at yields close to 6%, but at least they are still a far cry from the nearly 30% yield the Greek bonds are carrying. The major market collapse yesterday in Europe seems to have been overblown, and there already has been some recovery today as many investors filter back into the positions they abandoned yesterday. The issues are the same, but there is variability from day-to-day when it comes to investor faith.

The latest mood is slightly more upbeat on the subject of the Greek bailout. The sense is that something will happen to reduce the fallout from a Greek default and that has some feeling a little better about the potential for further collapse in other nations. The talk now is of a “managed default” that will reduce some of the impact on European banks and others exposed to the Greek debt. The aim seems to be to quarantine Greece and let the issues be their own as opposed to the concerns of the entire euro zone.

Analysis: The Europeans are simply confused. Everybody knows that Greece is in serious trouble, but they also know that there is capacity to bail them out. The Germans could have a change of heart and back the issuance of eurobonds or the IMF could ride to the rescue with another big loan. The Chinese might even step in. The point is that nobody has a good feel for what happens next. Even if Greece slips into default, there are few who have a sense of what that would look like. It is clear that it would be some kind of managed default, but that is murky at best. The scenarios range from an extreme position resulting in the explusion of Greece from the euro zone to something as limited as negotiated settlements with Greek debtors.

The real issue has and continues to be the Italians and the Spanish. The Italians are locked into the same bitter political battle with which the United States has been struggling. There is no consensus on what to do in Italy as even the ruling coalition is deeply split. The Spanish are in somewhat better shape politically as the Socialists are preparing to yield power to the Popular Party earlier than planned. The new prime minister will have far more latitude than the predecessor has had, but the issue in Spain is that a housing boom was followed by a massive bust and unemployment levels are still above 20%.

The market reaction to all this has been volatile as investors grab at every indication they see. Obviously, the US and Europe are not ready to resume their former positions of influence, and that leaves investors feeling a bit confused—again.

Source: NACM Economist Chris Kuehl

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