What has happened
Risk sentiment ended the week on a more positive note as the S&P rating agency’s decision not to downgrade Italy to High Yield boosted US equities late in the session. Looking to the week ahead we have a busy schedule the peak of US Q1 earnings reports, US Q1 GDP on Wednesday and a range of central banks meeting.
No downgrade for Italy
The decision by S&P to keep Italy’s credit rating static and not downgrade the coronavirus-stricken economy has given some much needed breathing room to European assets. The Euro suffered on Thursday as no meaningful progress towards an EU Recovery Fund was found at the EU summit. If S&P had downgraded Italy with that backdrop, we would expect Italian bond yields to suffer a sharp rebuke from investors. As it is, the S&P decision coupled with Moody’s view that their rating should be “broadly unaffected” by the economic damage of coronavirus, helped kick the can down the road. With European economies gradually reopening over the next few weeks, when the EU Commission does finally revert with a plan for the EU Recovery Fund in around 3 weeks’ time the market’s mood may be in a less fragile state.
What is the hurdle for further monetary stimulus
We hear from the Federal Reserve on Wednesday and the ECB on Thursday. We will probably not see any blockbuster stimulus announced by either central bank given the extraordinary stimulus already agreed during ad hoc calls between the formal meetings. Expect a status update on how the stimulus announced so far has progressed and any hints as to whether they are still concerned about market stability. Whilst nothing new is expected both banks will be nervous of any perceived communication error so they are likely to err on the side of caution with vague promises to act as necessary to support financial market liquidity and the broader economy.
What does Brooks Macdonald think
The decision by S&P to retain Italy’s rating is undoubtedly aiding risk sentiment today however it does put EU and Eurozone leaders under less pressure to coordinate support which may be a more substantial negative in the longer term. Should we see a successful reopening in European economies without a spike in new case growth, the urgency of a pan-European package will wane and with it hope of burden sharing across Europe. Italian debt to GDP is expected to rise by around 20% due to the coronavirus pandemic, even if a reckoning is avoided in this crisis, the weight of debt is an issue that will need to be addressed eventually.