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As alluded to in Monday’s market summary, the FTSE has persistently struggled to exert a foothold above the 6000 point mark. Wednesday saw the market capitulate on its latest endeavour after just two trading sessions, as news emerged that the ratings agency Moody’s had downgraded Portugal’s government debt by one notch to junk status. A subsequent Portuguese Treasury auction issued three-month bills at 4.926% on Wednesday, 1.3% higher than an equivalent issue on the 15thJune, demonstrating investors concerns over the country’s liquidity/solvency.

The danger has always been that contagion in the Eurozone could be precipitated by self-fulfilling prophecies, as demonstrated below.

A country’s credit rating is cut → yields rise as investors demand a higher return for holding the debt → the country becomes locked out of raising new funds in capital markets as the cost becomes prohibitive → this reduces available funds for redeeming existing debt → investors worry and want a higher return → yields rise again → the country finds it harder to raise new cash etc etc. You can see the picture building.

It didn’t take long for markets to digest the news with financials leading a decline which saw the FTSE at its lowest at around midday but gain some ground to finish down 0.35%. Whilst having limited exposure to Portugal, the FTSE’s constituent banks do hold a significant amount of Irish debt, the creditworthiness of which is now feared could be next in line for a down grade. This is of concern to owners of stocks with significant exposure because as yields spreads widen, capital values fall, leading to losses (often substantial) for the institutions holding the assets. The UK’s decline was positioned between the other main European bourses, with the DAX and CAC40 finishing down 0.11% and 0.44% respectively.

The risk off trade saw Brent crude fall 1.9% and gold and silver strengthen by 1.3% and 2.0% as investors fled to safer havens. In currency markets, sterling gained ground against the euro but was lower against the dollar, which traditionally benefits from inflows from risk adverse investors.

This was posted in Bdaily's Members' News section by John Dance .