Spain downgraded as the outlook for growth looks bleak

Another Southern European nation edged a little closer to the masked executioner in the early hours of Friday morning as the credit rating agency Standard and Poor’s squeezed down Spain’s rating from AA to the not-so-different AA-. Screaming its new-found negative outlook, it became clear that this combined judge and jury was making a statement just days after the European Commission announced that it had a plan and only a week after Fitch’s downgraded Italy in a similar fashion.

The fact is, casting our minds back to last week, the impact from the Fitch announcement pushed the Euro markedly lower at a time where uncertainty and fear of the sustainability of the Eurozones debts forced a hasty retreat the safety of the US Dollar. Today’s announcement, on the contrary, created some ripples of surprise but the inability of it to have such a drastic impact was a remarkably good test of market confidence. The Euro, despite one of its members being drawn into the mire of dangerous levels of sovereign debt, stood up rather well and ended the day considerably higher at +135 pips at the time of writing. This would have been almost impossible to imagine this time last week could be both a reflection of confidence in European pragmatism or quite simply that this news has already been factored into the price.


Having said this, Spain have got some serious issues. With around 20% unemployment it is one of the worst in the developed world, exacerbated by low economic growth and a rising discontent amongst its brightest young citizens who are not provided adequate opportunities for work. Although its sovereign and private debt is the overriding issue for many investors the undercurrent of discontent is inextricably linked to the state of the country’s labour market. Reforms have either not been successful or simply not carried out effectively and this will obviously have an effect on the future of national banking sector. Interestingly, S&P pointed to these issues as one of the factors for Fridays downgrade. One positive to be taken from this is the fact that finally a credit rating agency has realised that treating the symptoms will not necessarily cure the cause. In Spain’s case throwing bail-out money into the system would not be nearly as effective as radically overhauling the labour market and the positive creation of new sectors for its forgotten generation to form a part of.

Spain’s bond yield has been toying with the 5.2% mark, which is a reasonable distance from the 7% required for a bailout. These rates can rise quickly and news of the downgrade and the bleak outlook from the S&P perspective hints at the possibility of future cuts if things do not improve markedly. On a more positive note the Euro may also have been boosted by the final approval of Slovakia to the European Financial Stability Facility, clearing the way for this to be approved and perhaps a further boost the regional currency. Fundamentals, however, are still driving risk appetite and being that sentiment has changed so dramatically in the past week it would be wise to remember that financial markets are still both fickle and volatile.