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Euro Rises, Then Falls As Downgrade Fears Hit Markets

Javier E. David
Wall Street Journal
December 16, 2011

Hovering near 11-month lows, the euro ended Friday modestly higher, as investors feared that credit downgrades were looming for members of the 17-nation currency bloc.

On Friday, Fitch Ratings put six of the 17-nation currency bloc's countries on negative watch and lowered its outlook on France's triple-A rating to "negative" from "stable." Meanwhile, speculation is rife that Standard & Poor's may soon cut the ratings of one or more euro zone members, after putting 15 of the 17-nation currency bloc's members on negative watch on Dec. 5. Late Friday, Moody's Investors Service got ahead of both S&P and Fitch when it downgraded Belgium by two notches, to Aa3, citing the deterioration in euro zone bond markets.
Analysts say the disappointment following last week's European Union fiscal accord is converging with fears that aggressive moves by ratings agencies could inadvertently send already spiking euro zone borrowing costs spiraling higher. But absent any new impetus, traders were reluctant to drive the euro to new lows.
Although debt-laden Italy and Spain are in the market's crosshairs, France's own high indebtedness places the euro zone's second-largest economy in a precarious spot. Meanwhile, fears are growing that Germany - the Continent's economic powerhouse - is also at risk of losing its top-notch investment rating.
"Germany's economy is certainly the best house in a bad neighborhood," said Jason Ware, market strategist at Albion Financial Group. "France is a bigger worry given their weaker fiscal health and higher bank exposure to worrisome sovereign debt."
A cascade of credit downgrades could batter a region already suffering from weak growth and sovereign debt problems that have sent interest rates on Spanish and Italian bonds soaring recently, which helped drive the euro this week to its lowest level since mid-January at $1.2945.
Late Friday, the euro was at $1.3045 from $1.3016 late Thursday, according to EBS via CQG. The dollar was at Y77.78 from Y77.86, while the euro was at Y101.50 from Y101.35. The dollar was at CHF0.9354 from CHF0.9410.
The ICE Dollar Index, which tracks the U.S. dollar against a basket of currencies, was at 80.144 from about 80.321.
Traders took modest comfort in news that both the Italian and German governments had passed confidence votes, giving leaders the political capital to force through needed reforms to convince markets about their serious of fiscal reforms.
However, it's the threat posed by credit ratings agencies that is most disconcerting to investors. Those fears are merging with expectations that the 17-nation currency bloc will fall into recession by next year. Citibank expects the euro zone economy to contract for the next six quarters.
Given that the bonds of Italy and Spain have been savaged in markets, some observers say the ratings agencies may be behind the curve. The moves by Fitch and S&P reflect a new aggressiveness on the part of ratings firms to warn investors before circumstances take a toll on the creditworthiness of borrowers.
"By the time S&P downgrades something, the market has already downgraded it by several notches by perception," said Peter Schiff, president of Euro Pacific Capital. "All these credit agencies are way behind."

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