After weeks of prevarication and lots of rumours Standard and Poor’s finally put markets out of their misery on Friday, and pulled the trigger on France’s triple “A” rating, downgrading them to AA+, with a negative outlook. The negative outlook means France has a one in three chance that they could well get downgraded again in the next two years. A clutch of other downgrades, including Austria, Italy and Spain further complicates European leader’s attempts to resolve the debt crisis.

Despite the predictable wails of anguish from various EU leaders this wasn’t too much of a surprise, given where French 10 year yields have been trading in recent weeks.

The surprise is it took so long and it also gives rise to a more difficult problem, namely the bailout fund, the EFSF, and the rating currently allied to that. The downgrade and negative outlook on France is more of a problem for the fund, and has the potential to make things very difficult, not only for the EFSF, but also the ESM going forward.

The EFSF currently has a triple “A” rating, but that probably won’t last given S&P’s comments in December that a downgrade of any of the main Europe triple “A” nation’s would generate a downgrade on the fund as well.

On that basis this weeks EFSF bond auction will be closely watched for any significant rise in yields.

With Germany, the only major European triple “A” member left, pressure will mount for it to increase its contribution to the fund, to make up the shortfall, and as such the crisis has moved much closer to the inflection point where Germany finds itself manoeuvred into a corner, where it has to decide whether to go all in to save Europe, or step away.

A bigger problem now is the downgrade of Italy by two notches to BBB+, on a negative outlook, given that Italy has to roll over €36bn of bonds in February, and is still awaiting the outcome of a Fitch decision probably due later this month.

If that were the only problem EU leaders might be able to muddle through but the stalled Greece debt talks has brought the prospect of an eventual Greece default that much closer, probably in the next few weeks, unless something is agreed in the next week or so, when talks resume on Wednesday.

US markets are closed for Martin Luther King Day.

EURUSD – the break below the double support at 1.2660/70 late last week has seen the single currency push down towards the key 1.2600 level that represents the 76.4% retracement of the up move from the 2010 lows at 1.1880 to last years highs at 1.4940. It also coincides with the August 2010 lows at 1.2590.
A concerted break below this level would target 1.2480, the July 2010 lows and then on to 1.2000.
The key barrier on the upside remains the resistance around the 1 2870 area that we warned about last week.
If this 1.2870 area was to give way we could see an overspill towards the 1.3000 level and even towards the 1.3080 area.

GBPUSD – the pound triggered stops below 1.5270 late Friday, rebounding from 1.5240 but closed above the October lows at 1.5270. It was still the lowest cable close in 17 months, which suggests further weakness.
The 1.5190 level remains a key barrier given that it is 61.8% retracement of the 1.4230/1.6745 up move. There is also support at 1.5125, the July 2010 lows, a break of which targets 1.4980.
Rebounds should find resistance around the 1.5380 area while to stabilise in the medium term would need to get back above the 1.5570 area to retarget the 55 day MA at 1.5740.

EURGBP – the failure to consolidate above the 0.8320 level mentioned in Friday’s note, as well as the failure at the 0.8370/80 area, suggests that we could well see further weakness in the longer term.
The 0.8300/10 level should now act as resistance, on any rebounds, while the 0.8370/80 should also be a significant barrier.
The September 2010 lows at 0.8200/05 remain the key obstacle to further declines towards the 2010 lows at 0.8065.

USDJPY – maintaining the status quo here with support around the 76.50 area and resistance at a confluence of the 55 day MA at 77.55 and trend line resistance at 77.70 from the 2007 highs at 124.15.
The key support remains around the November 2011 lows at 76.50 which prompted last week’s pullback. Only a move and close below 76.50 opens up the all-time lows at 75.30.