Stocks slump on Greece and Portugal downgrades

US Treasuries soar on haven flows

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21:55 BST. A downgrade of Greece and Portugal’s credit ratings triggered a sharp sell-off in stocks and eurozone debt markets on Tuesday, adding to jitters as traders watched the “The Lloyd and Fabulous Fabrice Show”.

The FTSE All-World equity index dropped 2.1 per cent, the sharpest dip for the global metric since October 2009. The dollar and US Treasury prices rallied while the euro fell sharply – to its 2010 low point – as traders reduced their exposure to risky assets.

Strong reports by BP, Deutsche Bank, Ford and UPS boosted Asian shares, which were also building on continuing strong macroeconomic data from the US – where consumer confidence and home prices improved markedly.

Europe tried to extend those gains, but Greek worries sent them into a sharp tailspin after Standard & Poor’s cut credit ratings on Portugal and Greece to A- and BB+ respectively.

And while Wall Street had lately been able to shrug off eurozone debt default contagion worries, the double whammy of credit downgrades and accelerating financial regulation, plus the consequent plunge in the euro and surge in bond prices, seemed to finally spook US traders.

The S&P 500 fell 2.4 per cent – its steepest drop in two and a half months – and the Vix index, a measure of expected equity market volatility, soared 31 per cent to 22.81, its highest level in two months and its sharpest jump since October 2008, just after Lehman Brothers collapsed.

● Behind the headline figures, however, were details suggesting US traders hadn’t completely changed their tune on financials, a key engine of the recent market rally, as dramatically one might expect. True, S&P 500 financial shares declined 3.4 per cent on the day. But Goldman shares rose 0.7 per cent, and as much as 1.7 per cent earlier, as Fabulous Fab & Co. strongly denied any wrongdoing.

Credit default swap spreads of banks actually tightened during the day, according to Markit data, though they had gapped higher overnight. Citi and JP Morgan swaps both tightened by about 6bp, suggesting a decline in the market’s view of their riskiness.

“Credit spreads of US banks were negatively affected by the events surrounding Greece and Portugal,” said Pri de Silva, analyst at CreditSights, “which offset a potential improvement due to the impasse in the Senate.”

Plus, an expectations game was afoot. According to Thomson Reuters, analysts have raised their bank earnings predictions faster than any other sector, so even a small drop back next quarter would be an even bigger disappointment. And as David Bianco, chief equity strategist at Bank of America Merrill Lynch, points out, bank profits have driven much of the current earnings rally – with their reports mostly compete for the quarter, the S&P may have already enjoyed its bump for the season.

“About half the increase to our ... EPS estimates last week was from lower credit costs at financials,” Mr Bianco said. “Estimates climbed 9%, rising at a faster pace than prior reporting seasons. But this should significantly slow now that financials have reported.”

Greece, meanwhile, watched its sovereign credit spreads extend to a startling 800 bp, a fresh all-time record. No such relief for the Greeks.

● Selling in European bourses accelerated after the S&P downgrades. Strong results from BP and Deutsche Bank could not stop the FTSE 100 in London falling 2.6 per cent and the FTSE Eurofirst 300 retreating 2.6 per cent. The heavyweight mining and banking sectors did most of the damage.

The Athens stock market plunged 6 per cent and Lisbon fell 5.4 per cent.

In earlier Asian trading the Shanghai market had at one point fallen to its lowest level in six months, before closing down 2.1 per cent, as investors became wary of a slew of fresh share issuance. The Hang Seng lost 1.5 per cent in sympathy, and this helped push the FTSE Asia-Pacific index down 0.2 per cent.

Elsewhere in the region the mood was less glum, after a raft of earnings reports impressed. In Tokyo, the Nikkei 225 rose 0.4 per cent, although gains were capped by Wall Street’s soft close overnight.

● The euro plunged 1.6 per cent to $1.3175, at a one year low, as investors fled the single currency project. The dollar jumped 1 per cent on a trade-weighted basis on haven flows.

Sterling fell 1.2 per cent versus the dollar to $1.5272 as the latest opinion poll pointed to the election in May delivering a hung parliament that some believe would hamper moves to tackle the UK’s budget deficit.

● Portugal’s sovereign debt remained under pressure as investors feared Lisbon would be next to struggle in controlling its finances. The yield on the 10-year note rose 35 basis points to 5.58 per cent and the cost of insuring Portuguese bonds against default – as measured by credit default swaps – jumped 12 per cent to a new high.

Greek 10-year yields moved up 4bp to 9.56 per cent and the two-year yield soared 216bp to 16.08 per cent. Greek CDS rose 8.3 per cent, also a new high.

The yield on US 10-year notes fell 12bp to 3.68 per cent as perceived havens were sought. The gains moderated after a middling auction of $44bn two-year notes. The bonds priced 1.4bps higher than the market rate, suggesting an uptick in worries about possible inflation.

That’s the direction many have expected Treasuries to move as the US economic recovery proceeds apace and more supply – $129bn in total will be auctioned this week – hits the market.

“The Treasury market’s been on a short-term rally since the situation with Greece and sovereign risk has escalated,” said Jeffrey Elswick, director of fixed income at Frost Investment Advisors. “In our mind the fair value on the 10-year is about 4.5 per cent. We think there will be more selling once the markets get some more positive payroll information.”

● Commodities were sold heavily as traders reduced exposure to riskier assets. Oil fell 2.7 per cent to $81.90 a barrel and the Reuters-Jefferies CRB index, a commodities basket, lost 2 per cent.

Gold rose 1.4 per cent to $1,169.80 an ounce – the highest since December 2009 – as haven flight trumped the effect of the stronger dollar.

Follow Jamie Chisholm’s market comments on Twitter: @JamieAChisholm

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