Notes From Underground: S&P Downgrades Spanish Sovereign Debt to BBB+ (Another Example of Grade Inflation)

The rating agencies are in play again as a late afternoon press release stated that Spain’s DEBT IS NOT AS GOOD AS IT WAS YESTERDAY. Hard to believe it … S&P is really on top of their game. Again, you don’t have to be A WEATHERMAN TO KNOW WHICH WAY THE WIND IS BLOWING. This action, of course, will be the beginning of serial downgrades. As good collateral dwindles, it will put further pressure on the GERMAN BUNDS AND 2-YEAR SCHATZ as REPO TRADERS WILL GRAB THE BEST COLLATERAL. It explains why the SCHATZ TRADED TO A RECORD LOW YIELD OF 8 BASIS POINTS.

It is another example of the global bond markets being in total disarray as the world’s central banks have rendered the DEBT MARKETS IRRELEVANT AS A BAROMETER OF VIGILANTE VALUE. The biggest question will be: WILL THE DOWNGRADE LEAD TO MORE DELEVERAGING BY BANKS HAVING TO TAKE LARGER HAIRCUTS ON ASSETS SO AS TO RAISE CASH TO SHORE UP IMPAIRED BALANCE SHEETS? The initial response was to buy DOLLARS and sell risk assets. More downgrades will put to bed the PROJECTIONS FROM THE FED BOARD MEMBERS. Again, we must continue to ask why the German Schatz is yielding such a ridiculous price?

***Tomorrow the U.S. will release the first look at first quarter GDP. The market consensus is for a rise of 2.6%. A number below 2.2% would be initially bearish for equities, but the recoil will be a rally as the market rests comfortably with the idea that slower growth will keep the FED firmly in the TWIST CAMP. In addition to GDP, the EMPLOYMENT COST INDEX will be released. (The market is looking for 0.5% increase but this number is a more difficult read.) A higher number will mean that wages are rising which means pressure on corporate profits, but the end result is that the consumer will be deemed to be in better shape.

This is a difficult data set even without the impact of a Spanish debt downgrade. A strong set of numbers should provide some relief to the S&Ps, but the test will be if the rally holds with all the other uncertainties weighing on the market. The strength in the DEBT INSTRUMENTS TODAY are issuing a warning that some equity owners are reallocating some capital. A strong DATA SET WILL TEST THE REALLOCATION THEORY.

***Tonight (Thursday) we will hear from the BOJ. The YEN is holding its recent rally so let’s see if the Japanese authorities increase their liquidity program in an effort to weaken the YEN and prevent further possible erosion of Japanese manufacturing. The market is looking for a 5 TRILLION YEN INCREASE IN BOJ LENDING PROGRAMS WHILE SOME ANALYSTS THINKING AN ADD OF 10 TRILLION. Anything above 10 TRILLION should weaken the YEN (at least on the crosses although the EURO/YEN is a wildcard because of the S&P DOWNGRADE. If the EUR/YEN were to rally, it would be an indicator that the DOWNGRADE WAS FULLY PRICED IN THE MARKET WHICH SHOULD PROVIDE A SIGNAL FOR RISK ON.

***Bloomberg had an article about another possible indicator to evaluate the problems of Europe. In an article by Dave Goodman, it was reported that Sweden’s CDS soared this month as concerns are rising about Sweden’s exports suffering from contagion to the European economies. Sweden has enjoyed status as a haven from European debt stress but it seems that Swedish banks and exporters have large exposure to Europe: “The country generates half its economic output from exports, 70% of which go to Europe.”

Bottom line is that all the POLLYANNAS dismissing the impact of Europe on the global economy must have suffered from GRADE INFLATION. If SWEDEN, SWITZERLAND, JAPAN and others lose their haven status where will money go to HIDE with a very compliment FED and 8 BASIS POINTS OF YIELD ON GERMAN TWO’s. NOWHERE TO RUN AND NOT ENOUGH VAULT SPACE FOR GOLD.

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