Containment Failure

There is only one story today in the capital markets.  As European officials continue to debate private sector participation in Greece's second package, Moody's seemingly caught the market off-guard by slashing Portugal's rating 4-notches late yesterday--keeping it on negative watch and warning it may need a second aid package as well.  The market reacted to it in the expected ways in the US afternoon, but Asia seemed to shrug it off.  Europe has ignored Asia and followed the US lead. 

In recent posts, I have suggested that Ireland will not be able to go back to the capital markets next year as its assistance program assumed.  The government denies this, which they must.  Today the focus is on the logic that Moody's used to downgrade Portugal can apply to Ireland as well.  Moreover, while Moody's is the first to rate Portugal below investment grade, the other rating agencies may follow suit. 

There is a large blow out in credit default swaps and premiums the periphery pays over Germany.  European equities are mostly lower, the the DAX the main exception and financials are leading the way. 

The fissures among the elite in Europe are in full bloom today.  On one hand officials are clearly upset with Moody's decision.  On the other hand, the ECB is giving the rating agencies even more say away its collateral.   Moreover, the prudent thing to do is not take the most optimistic of the rating agencies but the most pessimistic. Another fissure is evident, just as the French plan seemed to be gaining traction, Germany has signaled that it will dust off its earlier bond swap proposals. 

The other focus today is China.   It hiked rates for the third time this year.  The one-year deposit rate was raised 25 bp to 3.5% and the one-year lending rate was hiked by a similar magnitude to 6.56%.  The fact that the deposit rate is still below the rate of inflation--negative real rate--will still discourage money flowing back ot the banks from the asset markets.    Inflation in May stood at 5.5% and there is speculation that while it may be close to a peak, it may rise closer to 6%. 

Separately, Moody's expressed concern about the Chinese bank loans, which has been anticipated by the market and other rating agencies (and my note about China: Strong but Fragile) and has seen Chinese bank stocks under-perform.  It did not help matters today that the Singaporean-based sovereign wealth fund reported sole its $43.6 bln stake in two Chinese banks. 
Containment Failure Containment Failure Reviewed by Marc Chandler on July 06, 2011 Rating: 5
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