PIIGS

Risk aversion increased sharply yesterday after Greece was downgraded to junk by S&P and Portugal was downgraded too. The market fear is that if Moody's also downgrades Greece below investment grade, then Greek banks won't be able to post Greek bonds at the ECB for collateral. This would cause serious problems for the country's banking sector. The S&P 500 was down 2.35% overnight and 10y Greek bond yields rose another 13bp to 9.67% while Portuguese bond yields spiked 48bp to 5.67%. This increases the pressure on EU/IMF funds to be distributed as soon as possible now to Greece. But the timetable remains difficult: 1) EU-IMF officials have to agree a package of reforms with Greece in Athens, most likely by this week. 2) The ECB and EU commission have to ratify this, which should be a formality. 3) Eurozone national leaders including Germany's Merkel have to approve it. 4) some parliaments including Germany and Ireland's have to pass laws approving the assistance. All this before Greece's next big bond rollover on May 19 of EUR8.5bn. If there is any 'good' news from last night's ratings downgrades, it is that it must now concentrate EU/IMF/Greek officials' minds so that they avoid Greece defaulting on this rollover. Thus in the near term, sentiment is likely to be very adverse as the market fears a re-run of the Lehman collapse 2008. But the likelihood remains for now that Greece will get the money in time. So for next two weeks, the euro will stay under pressure until funds are disbursed and then we should get a short covering rally in EURUSD.

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