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Spain has returned to center stage, with Moody's downgrade late yesterday of several regions and today's official admission of what many had long anticipated; namely that Spain's relaxed fiscal targets would be overshot.

And so it is.

Moody's passed on cutting Spain's sovereign rating (to below investment grade) recently and the general sigh of relief has been short-lived. Moody's cut Catalonia's rating (by two notches to Ba3) and four other regions. The ratings agency cited two main factors. First is the deterioration in the liquidity situation of the regions, as evidenced by the low levels of cash reserves. Second, it cited the heavy reliance on short-term credit lines.

Three of the regions that were downgraded (Catalonia, Murcia and Andalucia) face large redemptions before year end. Madrid had established a fund to help the regions secure financing of 18 bln euros. Eight of the 17 regions have requested funds, including 4 of the five that were downgraded by Moody's. These requests amount to a little more than 17 bln euros, practically exhausting the fund.

Separately, Spain's finance ministry acknowledged that this year's deficit, as in recent years, will overshoot the government's target. Indeed, this year's new projection of 7.3% overshoots not only the relaxed 6.3% shortfall, but even the 6.8% that Rajoy unilaterally suggested coming out of the EU meeting in which the leaders endorsed the fiscal pact. The 10.5 bln social security (not just pensions, but unemployment compensation and other transfer payments) deficit is being blamed, which itself is partly a function of the austerity face of economic weakness.

The Bank of Spain acknowledged what many expected, which is that the Spanish economy contracted in Q3 for the fifth consecutive quarter. The BoS estimate is for a 0.4% decline in output. That matches the Q2 contraction. The economy is now 1.7% smaller than a year ago.

This combination of events can only add pressure on Rajoy to request more formal assistance, in addition to the 100 bln euro bank backstop. Such anticipation may help explain the success of today's Spanish bill auction that raised a little more than it had anticipated (2.5-3.5 bln). The 3-month yield rose 21 bp from last month's auction to 1.41%, while the 6-month yield slipped 19 bp to 2.02%. These are solid results, but has done little for Spain's bond market, where yields are higher for the third day running.

The euro has consolidated within yesterday's range, which was also largely last Friday's range as well. And when everything is said and done, the euro is fairly resilient. It is the fifth consecutive session that it has held above the $1.3000 level. On the upside, the $1.3075-$1.3080 has blocked attempts higher. Look for a quiet range bound North American session.

Source: Storms In Spain