Overnight Sentiment: Another European Summit, Another Japanese Rating Downgrade

There was some hope that today's European summit would provide some more clarity for something else than just the local caterer's 2012 tax payment. It wont. Per Reuters: "Germany does not believe that jointly issued euro zone bonds offer a solution to the bloc's debt crisis and will not change its stance despite calls from France and other countries to consider such a step, a senior German official said on Tuesday. "That's a firm conviction which will not change in June," the official said at a German government briefing before an informal summit of EU leaders on Wednesday. A second summit will be held at the end of June. The official, requesting anonymity, also said he saw no need for leaders to discuss a loosening of deficit goals for struggling euro zone countries like Greece or Spain, nor to explore new ways for recapitalise vulnerable banks at Wednesday's meeting." In other words absolutely the same as in August 2011 when Europe came, saw, and did nothing. Yes, yes, deja vu. Bottom line: just as Citi predicted, until the bottom falls out of the market, nothing will change. They were right. As for the summit, just recycle the Einhorn chart from below. Elsewhere, the OECD slashed world growth forecasts and now officially sees Europe contracting, something everyone else has known for months. "In its twice-yearly economic outlook, the Paris-based Organisation for Economic Co-operation and Development forecast that global growth would ease to 3.4 percent this year from 3.6 percent in 2011, before accelerating to 4.2 percent in 2013, in line with its last estimates from late November... The OECD forecast that the 17-member euro zone economy would shrink 0.1 percent this year before posting growth of 0.9 percent in 2013, though regional powerhouse Germany would chalk up growth of 1.2 percent in 2012 and 2.0 percent in 2013." Concluding the overnight news was a meaningless auction of €2.5 billion in 3 and 6 month bills (recall, Bill issuance in LTRO Europe is completely meaningless) in which borrowing rates rose, and a very meaningful downgrade of Japan to A+ from AA, outlook negative, by Fitch which lowered Japan's long-term foreign currency rating to A plus from AA, the local currency rating to A plus from AA minus, and to the country ceiling rating to AA+ from AAA. Yes, Kyle Bass is right. Just a matter of time. Just like with subprime.

More on the downgrade from Reuters:


- The downgrade reflects growing risks for Japan's sovereign credit profile as a result of high and rising public debt ratios, said Andrew Colquhoun, head of Asia-Pacific Sovereigns at Fitch. "The country's fiscal consolidation plan looks leisurely relative even to other fiscally-challenged high-income countries, and implementation is subject to political risk," he said.

- Finance Minister Jun Azumi said the government will make efforts toward implementing social welfare and tax reforms. He was speaking to reporters after the downgrade.

- The dollar rose against the yen after the announcement, now moving around 79.74 versus the yen.


"Ratings agencies have been threatening to downgrade Japan since a while back if sales and welfare reform bills fell through, but today's move came as a little bit of a surprise in terms of its timing.

"It will surely serve as a wake-up call for Japanese policymakers but it won't have any impact on financial markets, as with past downgrades by other ratings agencies.

"The downgrade prompted a fall in the yen but overall financial markets are not reacting, and it is unlikely to affect safe-haven fund flows into Japanese government bonds in view of Europe's sovereign debt crisis."


"Japanese politics may be moving towards increases in the sales tax, but besides boosting income, you also need to curb spending to make public finances healthier.

"Given the current political situation, with politicians remaining reluctant on that front, a ratings downgrade could have been inevitable.

"A ratings cut generally offers politicians a good opportunity to seriously tackle the sales tax debate. But this is probably not the case at the moment in Japan."


"The initial market reaction has been to weaken the yen but I don't think that is sustainable. It is likely that the yen will remain strong.

"Foreign investor participation in the JGB market is low, so it is unlikely to have much impact on the FX market from a flow perspective. Also, Japanese investors are very sensitive to relative yields.

"If we see any yield differential moves we could see repatriation flows back into Japan. It will make it more attractive for Japanese investors to stay at home and not invest overseas.

"In such a low yield environment, it doesn't take much of a move to prompt a change in investment decisions."


"Given the political inaction and relatively weaker growth, and no development in regard to sales tax and the fiscal outlook, the downgrade is not a surprise.

"The yen has sold off a little bit, but the history of downgrades of sovereign debt in Japan is that yen selling is not sustained.

"That history and general market conditions would suggest to us that any further selling on this could be used as an opportunity to buy the yen.

"The yen could rebound based on the European situation deteriorating again. We are in a period of lull at the moment ahead of the (EU) summit tomorrow."


"The JGB market reaction was limited as market players are not swayed by the Fitch ratings.

"There is no change in the overall picture that worries about Europe's sovereign debt problems are prompting investors to pour money into Japanese government bonds, which are safer assets.

"In the event that Moody's and S&P downgrade to single-A, then some foreign investors may react by selling JGBs."


"Compared to past downgrades, the latest to a single-A status raises uncertainty about how foreign banks reassess risks and review their handling of JGBs.

"But I don't expect an immediate spike in JGB yields as domestic banks that are dominant JGB holders are unlikely to react.

"A downgrade by Fitch alone may not impact much but similar action by other rating agencies may. Moody's and S&P so far seem to have stable views on Japan's ratings so they may not follow suit immediately. But this may change if Japan's handling of tax hike plans stumbles."


As for the latest worthless European summit in a long series of worthless European summits, here is the summary:

Oddly enough, we no longer even have any "announced solutions", any promises or any bold statements.

Almomst as if Europe itself has given up.

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Finally, here is BofA with the actual overnight market blow by blow:

Market action

Asian equity markets extended gains for the second day in a row, with the regional benchmark MSCI Asia Pacific Index rising the most in one month, on speculation that China and Europe will do more to bolster economic growth. Korean's Kospi registered a solid gain of 1.6%, while the Japanese Nikkei rose 1.1%. The Hang Seng climbed 0.6% and Shanghai Composite increased 1.1%. On the flip side, the Indian Sensex shed 1.0%. 

European equities are trading 0.7% higher in the aggregate. That's slightly below their peak of 1.1% earlier in the day. European markets came off their highs after Fitch lowered Japan's sovereign credit rating one notch to A+ with a negative outlook. Fitch is worried that Japan is not serious enough about tackling the country's debt burden, which is the highest in the world. Investors quickly brushed off the downgrade as they focused on tomorrow's EU meeting, where European heads of state will discuss ways to bolster growth in the Euro area, as well as discuss the situation in Greece. Investors' hopes are high that concrete action will be taken to support growth. In our view, European leaders will, once again, over promise and under deliver. Meanwhile, at home, futures are pointing to a mild sell-off of 0.2% in the S&P 500 later today. That follows the strong 1.6% rally in the index yesterday. 

Treasury yields are backing up across the curve. The 10-year Treasury yield is up 3bps, to 1.77%, while the long bond's yield has spiked 6bp overnight, to 2.87%. In Europe, peripheral yields are rallying. Both the Spanish and Italian 10-years are 13bps lower, but Spain's yield continues to remain above 6%. The safe havens of UK gilts and German bunds are backing up just like US Treasuries. 

Worries about a Greece exit and a possible breakup of the Euro area are supporting the US dollar. The DXY index is 0.2% higher. That is having a negative impact on commodity prices, with crude off 0.5%, to $92.10 a barrel, while gold fell 1%, to $1,577 an ounce.

Overseas data wrap-up

In the UK, consumer price inflation slowed to 3.0% yoy in April from 3.5% in March. That was below consensus expectations for a 3.1% yoy rate. Meanwhile, core inflation was a tad firmer than expected, rising 2.1% yoy in April against market expectations of a 2.0% yoy rate. In the prior month, the core CPI inflation rate stood at 2.5%. The large drop was due to a rolling-off of large base effects in the prior year. Looking ahead, inflation pressures should continue to ease, as the economy remains stagnant and unemployment creeps up this year. 
Today's events

The only thing on the economic calendar today is the release of the existing home sales report at 10 am. It is likely to edge up by 2.5%, to 4.59 million saar, nearly reversing the decline in March. Pending home sales were strong in the first quarter of the year, which should translate to signed contracts in the spring. If the abnormally warm weather boosted activity in the winter, which we suspect it did, we would see signed contracts jump in the winter and closed contracts in the spring.