Following a report overnight from the WSJ that S&P would likely downgrade the credit ratings of France, Spain, Italy, Ireland and Portugal if the euro zone slips into another recession, which many economists say is likely, the entire overnight session was dominated by yet another period of fear and loathing out of Europe, further pressured by escalating uncertainty over EU summit after another meeting is called for Oct. 26. The headline scanning brigade will focus on Belgium where at 2 pm local time EU finance ministers will meet in to hammer out groundwork for the Oct. 23 EU summit. The result of concerns that absolutely nothing is resolved led to spreads for everything blowing out: at one point, France 10-yr Yield was up +6 bps to 3.21% (the widest spread over bunds at 119.01 since 1992), Italy 10-yr yield rose +3 bps to 6.05%, highest since Aug. 5, and the spread over bunds widens to euro-era record of 402 bps or most since 1996 and lastly the 10-yr Spain spread over bunds was +4 bps wider to 5.57%, with the Bund spread at 355, just tight of the August record of 398 bps. Still this was enough for the ECB to intervene and as the chart below shows, to purchase Italian BTPs en masse for the fourth day in a row, this time with a sizable amount, even as it is now confirmed that ECB interventions hav a several hour half life. And since the EURUSD and thus futures are now driven off the BTP price, everything rose when at 4 am Eastern the ECB began its daily intervention. Alas, at this point even 8 year olds realize that these are short-term liquidity measures while the long-term solvency problem is merely getting worse.
Below are the 4 ECB interventions sketched out:
And here is resumption in the surge of ECB deposits, which at the current rate of bank withdrawal from the market post the last MRO reset, will see the 2011 high taken out very shortly. No need to note that 3M USD Libor is now wider for the 50 something day in a row.
Lastly, here is the WSJ article that the market is now blissfully ignoring in hopes the ECB will always come to the rescue.
Bank ratings in the region would also take a hit under the two possible scenarios analyzed in the S&P report. "These stress scenarios are not our central expectation, but a simulation of the possible outcomes if such hypothetical events were to occur," the ratings company said.
"Although our scenarios take into account various debatable assumptions, we believe that they illustrate the likely general direction under given conditions," it added.
The prospect of Europe falling back into recession has increased amid the recent tumult of dismal economic data. A preliminary survey of purchasing managers in the 17-nation euro zone fell into contraction in September, meaning the private sector posted less activity last month than in August. It was the first monthly decline in activity since the euro zone climbed out of recession in the third quarter of 2009.
S&P analyzed the outcomes of two possible scenarios: a double-dip recession within the next four years, and recession coupled with rising borrowing costs for companies.
The second scenario didn't include governments or banks, as "we consider that support mechanisms from the EU and the IMF would keep borrowing costs low for sovereigns in difficulty, and we assume that the European Central Bank would provide effectively unlimited support to euro zone banks during 2011-2014," it said.
A recession alone would be enough to knock down the ratings of the five countries by one or two notches, as ballooning budget deficits and bank recapitalization costs would send government borrowing "significantly higher." The current EU and IMF funding mechanisms are sufficient to support borrowing requirements of Greece, Ireland and Portugal, and a "small sliver" for those of Italy and Spain.
"This safety net, however, would be insufficient if conditions were to deteriorate along the lines indicated in our stress scenarios, prompting a higher level of support for Italy and Spain," S&P said.
As a reminder, Goldman has already called for a "mild" recession in France and Germany. And should France be downgraded, which it will, Europe's fate is sealed.