Europe Economy

Is EU Plan the Silver Bullet Markets Are Looking For?


Risk is back on the table after a terrible end to last week for the bulls. Following news of "Operation Twist" from the Federal Reserve, the market sold off aggressively, adding the pressure on policy makers as they met in Washington over the weekend to try and find a plan to avert a euro zone sovereign debt and banking crisis.

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On Monday, volatility was huge with stocks in Asia driving those in Europe lower at the open before a huge rally on hopes that G20 finance ministers in Washington had found a way to turn sentiment around.

Before the US Close, CNBC reported that European Union officials were considering providing seed money for a special-purpose vehicle that would be able to issue bonds and buy up euro zone sovereign debt. CNBC has heard talk of as much as an eight-to-one leverage ratio, depending on how much capital comes from the European Financial Stability Facility (EFSF). Plans for levering the EFSF were described as well advanced.

The EFSF is a vehicle financed by euro zone members, created last year, that's designed to provide financial assistance to euro zone states suffering economic difficulty.

That report and similar comments from members of the ECB’s governing council saw stocks soar following a brief wobble on the back of some weak US housing data.

The risk-on trade is again dominating on Tuesday, but as Angela Merkel meets her Greek counterpart in Berlin and protestors prepare to take to the streets of Athens, questions are beginning to be asked about whether the proposed plan will be the silver bullet investors are hoping.

EU Works to Lever EFSF Money

"At face value, this program would help deal with the immediate fall-out from a Greek default by easing concerns about the impact both on other peripheral governments and the banks. As such, it might be enough to prevent a complete financial meltdown,” said Julian Jessop, an economist at Capital Economics in a research note who believes investors need to consider two major caveats.

“First, the plans are still a long way from being agreed. Second, even if they are implemented, the suggested measures would do nothing to address the fundamental economic problems in many countries, including the costs of years of fiscal austerity and the loss of competitiveness while locked into the euro.” said Jessop.

“Overall, the reported proposals are perhaps the minimum required to buy some time in the event of a Greek default. But, just like the many previous bailout packages, they would not be a permanent solution.”

Others agree that we are a long way from an agreement.

“Granted, there is no smoke without a fire, but a political consensus on such new measures seems very far off,” said Benjamin Schröder, an analyst at Commerzbank on Tuesday.

“Even if the ratification of this package is completed, which seems highly likely though not a foregone conclusion, it is liable now to appear as ‘too little, too late,’” said Stephen Lewis, the chief economist at Monument Securities in a research note.

“To suppose that these matters will be ironed out in time for the G20 meeting in Cannes is, to say the least, highly optimistic,” said Lewis

Erik F. Nielsen, the chief global economist at Unicredit has just arrived back from Washington where he met with officials and other investors and the mood was not good when he got into the US capital.

“In a nutshell, investors arrived very bearish late last week, and as they started talking to each other - and to policymakers - the mood went from bad to worse to near-desperation.” said Nielsen.

“Predominantly, people worried about Greece, about Italy and about the European banking system as a whole. While I share these worries, in my opinion, the market has panicked beyond recently,” he said.

As he returned to work, trading screens where awash with green as investors bet it was time to take on risk, but Nielsen warns those hopes could be disappointed.

“I hope the market reaction was a reflection of moderately good news and a more sober evaluation of risks - and not based on some of the crazy rumors also circulating of a multi-trillion euro ring-fence, and a fundamental shift in ECB policies, because if those were to be the basis for the market reaction today, then I think we'll soon be disappointed again,” said Nielsen.