Spain's future brightens as it dodges downgrade bullet

Moody's refrained from slapping Spain with a junk rating, based on an assumption that Madrid will tap the ESM and reflecting progress on fiscal and banking reform. The decision was a pleasant surprise for investors.

Spain's future is looking a little brighter than it has in recent weeks, after Moody's left the troubled country's credit rating in investment-grade territory.

The decision to refrain from slapping Spain with a junk rating was based on an assumption that Madrid will tap Europe's bailout fund, the European Stability Mechanism, and reflects progress the country has made on fiscal and banking reforms, said Moody's late Tuesday.

It was also a pleasant surprise for investors.

"By passing on the opportunity to downgrade Spain's rating to junk, Moody's removed one major uncertainty from the financial markets, and investors around the world have responded positively," said Kathy Lien, managing director of foreign exchange strategy for BK Asset Management.

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The euro broke through the $1.30 level Wednesday and is trading at a one-month high versus the dollar, while the yield on Spain's 10-year bond fell as low as 5.462%, the lowest since early April. Spain's benchmark IBEX 35 index jumped more than 2% Wednesday.

Meanwhile, the cost of insuring Spanish government debt against default dropped to a 15-month low, according to data from Markit.  The spread on five-year Spanish credit default swaps, narrowed to  277 basis points from 347 basis points.

While Spain avoided a downgrade by Moody's, the rating agency still maintains a negative outlook on the country given the challenges that lie ahead.

Spain has yet to formally ask for a bailout, but expectations are that it will soon seek a line of credit from the ESM, which would allow the European Central Bank to start buying its bonds.