Euro mkts eye ESM action after Spain's downgrade: Verstrate

Global rating agency Standard and Poor's (S&P) decision to cut Spain's credit rating one notch above junk status might just push it into asking for a bailout now. Bruno Verstrate, CEO of Lakefield Partners feels it is now a test of the newly constituted European Stability Mechanism (ESM) and the European markets will be seeing how it can help Spain.

Verstate also told CNBC-TV18 that the euro-dollar has been a perfect hedge for euro investors and the dollar is likely to strengthen going forward.

Here is the edited transcript of the interview on CNBC-TV18.

Q: The S&P event has come and gone, very close to junk status, what is the market watching out for now?

A: I think this could force Spain to ask for help a bit faster than the market is expecting at this stage. We know that, it will come eventually of course. Politically it is a bit difficult to admit that you need it.

There is still a bit of political pride going on but, the market in Europe is actually waiting to test the European Stability Mechanism (ESM) in practice. I think the first test of the new emergency front that is in place and active now will be testing whether they can help Spain in a sufficient manner or not.

Q: We have been seeing this jitteriness in the market over the last 3-4 sessions, in fact the euro dollar fell by about a cent before the S&P downgrade for Spain came in and yesterday when the news is out the euro-dollar was largely steady, just about 0.002%, Do you think some of this jitteriness could be behind us now that the negative newsflow is in? What else are you watching out for in the near-term?

A: Concerning the euro-dollar, I believe that the elections in the West are going to be crucial to see how they handle the fiscal cliff. That will for sure determine the price going forward and on top of it, the Spanish situation in the more near-term will definitely put the euro-dollar volatility up again.

So far what is quite interesting is that euro-dollar has been a perfect hedge for euro investors. Every time the markets went up, the dollar against the euro dropped a bit and vice-versa. If you were exposed to dollars it was a good equity hedge, which is quite new.

One needs to look at the end of the year, which is a bit special. For foreign exchange there is lot of companies that need dollars. That could actually keep the dollar quite strong going forward. But, obviously political events can shake that immediately.

Q: Are you expecting Moody's to further downgrade Spanish bonds? At the moment the Spanish bond yields are standing at pretty close to the 6 percent mark, we have not seen that in sometime now. Are you expecting Moody’s to go one step ahead and downgrade it to junk?

A: I think they are all waiting to see whether they will ask for help or not. Also the internal politics will probably determine that agenda. The parliament has voted against the referendum of Catalonian independence but, I believe that most rating agencies will definitely wait to see where they are going. They will wait for the regional elections to pass before adjusting the ratings further. It will make no sense to downgrade it further knowing that they have a perfect back-stock by the ESM.