Cross posted at Shelter Harbor Capital October 17, 2012
Moody’s long awaited ratings decision has finally arrived and, and, and…it is a non-downgrade. In its reasoning for the non-downgrade, Moody’s cited the Eurozone’s willingness to backstop Spain. From Moody’s :
Moody’s assessment that the risk of the Spanish sovereign losing market access has been materially reduced by the willingness of the European Central Bank (ECB) to undertake outright purchases of Spanish government bonds to contain their price volatility. The rating agency believes that Spain will likely apply for a precautionary credit line from the European Stability Mechanism (ESM).
Ultimately, the financial burden lies with Germany and markets have not lost sight of this fact. The spread between Spanish and German bonds has compressed dramatically to below 400 bps.
Typically, a spread above 400 bps has signaled crisis, now the market is clearly of the belief that Germany will pay the bill for the periphery excess. This now sets up an interesting dynamic where any whisper of German opposition to a Spanish bailout could create a panicked risk off move. Thankfully the markets appear to be sufficiently conditioned to the random musings of European politicians.
We have long held the belief that Europe needs a combination of debt monetization, currency weakness, and economic growth in order to reduce debt to GDP ratios. A Spanish precautionary credit line which triggers the ECB bond buying program would be the first step in this process.