Fitch

European markets started off on a quiet note with thin volumes as equities drifted lower and fixed income gradually made gains, however newsflow rapidly picked up as commentary from the ECB President Draghi picked up wide attention. The ECB President was very upbeat on the Eurozone’s future, commenting that the bank will do whatever is needed to preserve the Euro, fuelling the asset classes with risk appetite across the board. European equities as well as the single currency erased all losses and the Bund moved solidly into negative territory. As such, EUR/USD is seen comfortably back above 1.2200, with both the core and peripheral bourses making progress. In the wake of the moves, attention is particularly being paid to Draghi’s comment that if monetary policy transmission is affected by government borrowing, it would come within the bank’s policy mandate. As such, much of the focus now lies firmly on next week’s policy decision from the ECB.

The major European bourses are down as US participants come to their desks, volumes still thin but higher than yesterday’s, and underperformance once again observed in the peripheries, with the IBEX down 2.5% and the FTSE MIB down 1.2%. Last night’s outlook changes on German sovereign debt caused a sell-off in the bund futures, with the effect being compounded as Germany comes to market with a 30-year offering tomorrow. The rating agency moves, as well as softer Euro-zone PMIs and reports that Spain is considering requesting a full international bailout have weighed on the riskier asset classes, taking EUR/USD back below the 1.2100 level. Furthermore, with Greece and a potential Greek exit now back in the news, investor caution is rife as the Troika begin their Greek report of the troubled country today.

Nice equity (and commodities) close (DAX futures peaking at +2%).

Didn’t seem to impress EGBs, though. Nor credit, as it stands. No ROn mode behaviour here. And certainly not for Italy.

Two of the three major credit ratings agencies have recently affirmed their outlook on the US sovereign credit rating, but all three continue to hold a negative outlook on the rating. In Goldman's view there is little likelihood that additional ratings actions will be taken this year, but the possibility of a ratings change is another risk posed by the "fiscal cliff," debt limit, and related debate over medium-term fiscal reforms that looks likely in 2013. All three rating agencies look likely to reassess the rating over the next year or so. In light of the recent announcements and upcoming fiscal events that could influence the rating, Goldman Sachs Economics team provides some updated thoughts on the intersection of fiscal policy and the US sovereign rating, in Q&A form.

The decision to downgrade Italy's rating reflects the following key factors:

1. Italy is more likely to experience a further sharp increase in its funding costs or the loss of market access than at the time of our rating action five months ago due to increasingly fragile market confidence, contagion risk emanating from Greece and Spain and signs of an eroding non-domestic investor base. The risk of a Greek exit from the euro has risen, the Spanish banking system will experience greater credit losses than anticipated, and Spain's own funding challenges are greater than previously recognized.

2. Italy's near-term economic outlook has deteriorated, as manifest in both weaker growth and higher unemployment, which creates risk of failure to meet fiscal consolidation targets. Failure to meet fiscal targets in turn could weaken market confidence further, raising the risk of a sudden stop in market funding.

The global economy is an entangled affair, make no mistake in your calculation here, and the numbers from around the globe are telling and will affect both the U.S. bond and equity markets. Much of the financing for the Emerging Markets was provided by the European banks and as they pull back and reorganize based not just on Basel III but based upon problems of the sovereign where they are domiciled the situation exacerbates. Two of the world’s financial axises are slowing and troubled and to not think that this will not affect America will lead you to conclusions causing you to play the Great Game badly. What did the meeting of the European Finance Ministers accomplish; not much. They nodded to the Spanish banks and agreed to inject $30 billion by the way of the sovereign, increasing the debt of Spain, with veiled promises of a new ESM fund which would lend money directly to the banks at some point in the future and this point is highly subjective depending upon to whom you listen. The Spanish claim within days or weeks while the Germans indicate it may be sometime next year. There is now a “maybe-maybe” timeline in Europe for almost anything as the weaker nations prod the stronger nations for more money.

Now that all know bank collapse is guaranteed, what assinine steps will be taken next?

While the world has known for over two weeks that the Spanish banking system is insolvent and locked out of global liquidity, the country was reticent about formally bowing down to Germany and announcing in proper protocol that it was broke. Until a few hours ago, when Spain's Economy Minister Luis de Guindos Monday sent a letter to Eurogroup President Jean-Claude Juncker, as expected, formally requesting aid to assist with the recapitalization of Spanish banks that need it, the ministry said in a statement. Sadly, at this point we can all just sit back and await for the next Spanish bailout letter demanding more cash, because, as we have explained on several occasions, the ultimate funding need of Spanish banks will be well over €100 billion, as further confirmed overnight by another analysis from Open Europe, which notes the patenly obvious: "Up to mid-2015 Spain faces funding needs of €547.5bn, over half its GDP and a large majority of its debt."

Two days ago we noted with muted disgust that Europe has legislated to scrap the use of rating agencies, who were everyone's best friend during the up-phase in the global ponzi, but now that deleveraging is accelerating and ratings downgrades are coming, are like the drunk guest who refuses to leave the insolvent party at 4 am. Sure enough, the time has come to enact rules to kick them out. But wait, there is much more. Moments ago Reuters reported that the European Central Bank is discussing a medium-term plan (as in indefinite) to scrap rating rules on euro zone sovereign bonds and instead set their value when used as collateral in lending operations on its own internal assessment, central bank sources said. You read that right: the ECB itself will decide what the collateral value is of pieces of paper it accepts, in exchange for other pieces of paper with the faces of famous dead people on one side (even if technically the whole operation takes place electronically). And to think that for some odd reason allowing drug addicts to write their own prescriptions is illegal. Apparently all is fair in love and breaking all rules of sinking monetary systems.

All you can read.

Relief in the markets, after the worst case scenario from the Greek elections was averted, proved to be decidedly short-lived. Although the pro-bailout New Democracy party came in first with 129 seats (with an additional 50 seat bonus) the markets still await confirmation of an actual working coalition given a caretaker government has been in place now for approximately two months. A degree of uncertainty in regards to the demands the new coalition will place on negotiating the country's bailout terms has resulted in many investors being unwilling to get their toes wet just yet. Away from the election fever, rising Spanish yields continue to spook the market with the 10yr yield breaching the 7% level, prompting aggressive re-widening of the 10yr government bond yield spreads. The move comes at a crucial time for Spain as they look to come to market tomorrow in 12 and 18 month bills followed by three shorter dated bonds to be tapped this Thursday. Meanwhile, the FX markets have reflected the shift in sentiment with EUR/USD well off its overnight highs and the USD index firmly supported by the prevailing flight to quality bid. However, the biggest currency move of the day came in the early hours after the rupee (INR) weakened substantially following the RBI's decision to leave rates on hold, this coupled with Fitch changing the country's outlook to negative from stable has kept the currency under pressure throughout the day.

For your definitive documented "X is not Y" atlasing needs.

The most effective response for Spain would be to de-link sovereigns and their banks, following recent steady accumulation of sovereign debt by peripheral banks, in our view. Reducing the link between Spanish banks and the sovereign remains one of the key aspects for relieving pressure on Spain, whether this be by removing sovereign debt from balance sheets or ensuring sufficient capitalization to absorb losses. Unemployment out this morning at 24.4% shows the fragile state the economy is in, which is likely to keep pressure on Spanish yields. Against this backdrop the effect on the asset side of balance sheets is concerning, with expected weakness in non-core government bond prices coupled with a weak economy decreasing individuals' and corporates' ability to repay

We were wondering how long Europe's insolvent, and very much scorned, banks would take the constant downgrade abuse (or reacquaintance with reality as we like to call it, but that is irrelevant) by the rating agencies without retorting. After all the same organizations that allowed bank "credit analysts" to pretend they did work for years, when they all merely fell in place in some lemming-like procession, patting each other on the back, pocketing record bonus after record bonus and praising groupthink encapsulated by the made up letters AAA, are now largely non-grata first in Europe, and soon, following the imminent downgrade of American banks, in the US as well. It appears that the response is finally coming. Sky News reports that "some of Europe's largest banks are intensifying discussions about a move to reduce their co-operation with the big three credit ratings agencies amid widespread dissatisfaction with their decision-making." After all, when all they do is downgrade, as opposed to the old standby, upgrade, who needs them. In fact, why not just shut their mouths entirely. Sadly, this is precisely what is on the horizon.

Equity markets have traded with moderate volatility so far today as peripheral news concerning Spain and Italy continues to be keenly watched by market participants. Overnight the Italian PM Mario Monti said he does not see any need for a bailout either now or in the future with the Italian and Spanish 10yr yields seen off their highs yesterday, lower by 9.8bps and 7.6bps respectively. On a sector breakdown tobacco stocks saw some slight support after US firm Philip Morris announced a new USD 18bln 3yr share buyback program, however, industrials have lagged as a whole following a profit warning from Swedish firm SKF. In terms of fixed income, the bund has continued yesterday's slide with the Bundesbank coming to market with a July 2022 tap. In initial reaction to the results, bunds saw a 20 tick spike higher, off session lows, following what was perceived to have been a "smooth" auction despite some concerns about the eventual credit worthiness of Germany given the recent bailout of the peripheral nations. Meanwhile, the long end of the EUR curve steepened in early trade as reports from the Danish government who have agreed to change the discount rate that pension funds estimate liabilities being noted. In FX, EUR/USD trades higher into the N.American cross-over with an Asian sovereign name being a touted buyer this morning. In other news the AUD also caught a bid shortly after comments from the German central bank who said that they are considering buying the antipodean currency.