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"Risk-free doesn’t exist anymore"

Market impact following S&P potential downgrades

Well, ratings agency S&P has certainly caused a storm.

After announcing that it has placed all eurozone sovereigns on a credit watch for a downgrade, with five AAA rated sovereigns on a list for a one-notch downgrade, with a sixth, France, being highlighted by S&P for a potential downgrade by two notches - market participants are reacting vehemently to the news.

Speaking of which, Mike van Dulken, Head of Research at trading services provider Accendo Markets revealed to Euromoney, the volatile market scenario if the downgrades were to come into fruition.

- Uncertainty over bond yields and thus future sovereign financing costs could see markets stay as choppy and jerky as they have been.

- Possible extended volatility (sentiment swings) for banks which are extensively interlinked.

- Any risk-off also likely to impact mining sector (recession = lower industrial demand and dollar haven-seeking making commodities more expensive).

- Banks and miners together = big chunk of FTSE100.

- Loss of AAA would likely mean EFSF bonds find it even harder to raise money at attractive yields. Periphery would likely struggle if guarantors take a knock.

- Same with Eurobunds, if they materialise.

What’s clear is that risk-free doesn’t exist anymore.

However, Van Dulken did say that some market participants are already priced in, except maybe for Germany, if we look at bond yields as indicators.

He also highlighted:

Others see AA+ as new AAA in which case nothing would change relatively speaking.

[The] US got cut and the USD still safehaven of choice.

Then again, a downgrade just adds to weight of negative sentiment which can become a burden, even though ratings agencies usually late to the party, reacting to cumulative of what we already know (normally)

While market participants have remarked that the AAA sovereigns on the ratings watch were not entirely unpredictable, the prospect of Germany being downgraded would be more of a surprise.

Van Dulken says:

A German downgrade would be more of a surprise.

Then again, on its own it seems to be faring well (factory orders beat expectations by a mile this morning), however, Germany remains part of Europe and thus exposed.

No matter how good a driver you are, your insurance premium is dictated mostly by safety of your neighbourhood and how bad local drivers are.

Never say never I say. We didn’t think US would see a cut

- Euromoney Skew Blog

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