Before getting into the nitty-gritty of the situation, let’s do a quick background check on the Ireland’s public finances.
Since 2009, Ireland’s budget deficit has been the highest in the euro zone. Its deficit stood at a whopping 14.3%, but investors weren’t too worried because Ireland had a solid plan to trim down its deficit. However, as time went by, the plan proved to be a wee bit too ambitious. Recent reports have shown that the costs associated with bailing out some Irish banks are well above initial estimates. To top it all of, S&P decided to lower Ireland’s sovereign credit rating to AA- from AA.
The underlying economic weakness of Ireland and the S&P downgrade have made investors worried. As a result, from early August, Irish bonds have been sold-off, with their spread considerably widening compared to other euro zone nations, most especially against German bunds.
For those of you who fell asleep in International Finance 101, when spreads widen, this signals uneasiness in the markets. Remember, investors always want to be compensated for any additional risk, so if spreads are widening, it means that investors see those assets as risky business (no, not the movie).
The downgrade comes at a bad time, as concerns about the slow progress of global recovery have been hitting the airwaves. First, we get more and more poor economic data from the US. Secondly, despite the “success” of the EU stress tests, recent news have shown that Greek and Spanish banks need to borrow more from the ECB. And now, fresh euro zone debt worries? I don’t know about you, but this might be enough to fuel sceptics’ worries that we are indeed headed for a double dip recession. This is certainly not what everyone wants to hear on his or her iTunes play list.
Of course, the dominating thought that comes to mind for all you Forex traders is this:
What now for the euro? EUR/USD back to parity anybody?
Now, some have shrugged off the S&P’s opinion precisely because they already saw another downgrade coming. It’s no secret that the euro zone’s debt issues are a key factor weighing down the currency, so why make such a big fuss about something that you already knew was bound to happen?
And besides, Europe’s core economies (shout out to my boy, Germany!) seem to be outperforming the US. Some say it won’t be long until risk aversion tones down and fundamentals once again dictate price action.
On the other hand, there are those who say that the euro’s defeat on the charts yesterday was only the first of many. Coupling yesterday’s downgrade along with the previously mentioned difficulties of Spanish and Greek banks to find financing, is it only a matter of time before the Debtness Monster begins lurking around once again?
It might be too early to tell which direction the euro will take over the next couple of months. We may have to wait a little longer to see how S&P’s downgrade fits in the currency’s fate on the charts.