Good news from Europe! The euro surged Friday morning on news of a deal to help recapitalize banks. Bond yields in Spain and Italy fell. Stocks around the world rallied and there was a nice pop on Wall Street as well.
Bad news from Europe! The euro surged Friday morning on news of a deal to help recapitalize banks. Bond yields in Spain and Italy fell. Stocks around the world rallied and there was a nice pop on Wall Street as well.
Every time European leaders announce some sort of piecemeal solution to the continent’s debt crisis, the financial markets act as if the ref just blew the final whistle to end a soccer match. (Forza Azzurri!)
Unfortunately, that gives European leaders a false sense of security. We’ve seen this play out numerous times since Greece first started dominating financial headlines in early 2010.
The euro jumped to nearly $1.27 Friday. The fact that it remains higher than where it was at its lows during the summer of 2010 means that the market still doesn’t believe there is a realistic chance that the eurozone could unravel. Absent that fear, European officials can be content doing little to tackle long-term problems.
“Once again, we are seeing this knee-jerk reaction where bond yields fall and the euro and European bank shares rally. But after a month, this may all come undone and countries will be going back to the begging bowl. It’s sad that investors continue to fall for this,” said Graham Summers, chief market strategist for Phoenix Capital Research in Charlottesville, Va.
To be fair, the agreement to give a single body use of the EU’s bailout funds to assist banks is a step in the right direction. But it’s a Band-Aid when what’s needed is a tourniquet.
“Taking care of recapitalizing the banks does help, but both sides have to give more concessions. Europe has to issue eurobonds and there needs to be pan-European taxation and control over budgets. That is what is nagging the eurozone,” said Boris Schlossberg, managing director of FX Strategy with BK Asset Management in New York. “This is by no means an end.”
So what’s next? Probably more rhetoric and political posturing. Keep in mind that the permanent bailout fund, known as the European Stability Mechanism, still doesn’t technically exist. It must be approved by all 17 of the nations using the euro currency by July 9.
That’s less than two weeks away. There is no time for EC president Herman Van Rompuy to call together another one of his treasured summits in Brussels or issue a Kumbayah-esque communique about the importance of unity before then. Leaders will have to stop talking and actually do something.
“The problem with the euro is that it’s a constant battle between politics and economics. Leaders understand what needs to be done but don’t seem capable of acting on it. Keep in mind that there is a big gulf between what leaders promise and what they actually do,” Schlossberg said. “This is not a time to rest on their laurels. They need to back things up with quick action.”
There’s also the tiny issue of how Europe really intends to fund the ESM.
“There is a lack of credibility and questions about where the money for the ESM is going to come from,” said Camilla Sutton, chief currency strategist with Scotiabank in Toronto. “This plan doesn’t accomplish everything and doesn’t provide a plan for the type of longer-term ties that are needed. It’s not a dramatic enough change to keep the euro rallying.”
Summers notes that about 30% of the ESM’s capital is supposed to come from Spain and Italy … the two nations that are arguably in most need of assistance.
“Spain and Italy are going to bail themselves out? That’s ridiculous. If Europe can find an extra trillion or 1.5 trillion euros lying around to put to use, that would be helpful,” he quipped.
Schlossberg added that the only way to truly stop the bleeding in Europe is for the European Central Bank to step up like the Federal Reserve has done. So far, the ECB has not been willing to be as aggressive as the Fed. That could change soon though. The ECB meets next week and there are growing calls for it to lower rates from their current level of 1%.
“The ECB is the only actor that can fix things quickly. It needs to come in and provide massive liquidity, slash rates and buy sovereign debt,” Schlossberg said.
What if that doesn’t happen? Sutton thinks the euro will likely remain in a narrow range. It’s unlikely to strengthen to above $1.30. And even if it weakens slightly, that won’t set off any alarm bells since it would help make European exports more competitive. The euro would have to plunge to finally serve as a true wake-up call. “Concerns would only develop if there was a sudden, quick shift down in the euro,” she said.
But that’s unlikely. So we may be talking about yet another summit in the fall where yet another new plan is announced that saves Europe once and for all. It will be met with a euphoric reaction at first — and then reality will once again set in.
All the while, the rest of the world will continue to languish since there is no global recovery without Europe getting back on its feet. China is slowing and will slow further if its biggest trading partner remains comatose. That in turn will hurt Brazil and other emerging markets. And it will hurt the United States.
“Europe is frustrating,” said Sanjeev Sardana, chief executive of BluePointe Capital Management in San Mateo, Calif. “There is still a lot to fear because the global economy is starting to suffer. Decoupling is a myth.”