Trader Talk

No EFSF Deal Means Wider Contagion

Market are expecting more volatility. Dean Curnutt and others have noted that the S&P 500 is near where it was a week ago (1,202) but the VIX is almost 20 percent higher (from 30 to about 36). Market are expecting higher volatility because a lot is unsettled in Europe.

The main issue is this: will there be enough done to help Spanish and Italian funding costs from spiraling out of control?

The early reaction in the markets is not favorable: Italian 10-year bonds are now over 6 percent for the first time since early August.

That's because if an agreement on the EFSF is not reached, it signals trouble for the ability of the EFSF to adequately buy sovereign debt.

But a delay in an agreement does not mean there won't be an agreement. German Chancellor Angela Merkel and French President Nicolas Sarkozy have already issued a joint statement saying they will have a "definitive agreement" on recapitalization of European banks and expanding the EFSF "by Wednesday, at the latest." Whether the plan will mollify the markets is unclear. President Obama made it clear he expected some kind of roadmap before the G20 summit on November 3rd.

Regardless: there are legitimate concerns that the EFSF may not have enough money to buy Spanish and Italian debt even with an agreement, due to a relatively small pool of funds available. The G20 summit may produce proposals to increase commitments to the IMF, perhaps from emerging market countries, which could then provide funds to the EFSF directly or indirectly.

Convoluted? Yes.

Three questions still floating around:

1) Where's the Greek bond discussions? Discussions this morning have been focused on the EFSF, but there has been no word from Greek bondholders that they will agree to a larger haircut than the 21 percent proposed.

2) Eurobonds? Not possible now, but there will likely be some statement about setting up a group to draft treaty amendments that would start the process that would make eurobonds feasible. Whether this would pass a popular vote in the Netherlands, France or anywhere else is not clear.

3) Where's Draghi? There is a new ECB President, Mario Draghi. He may not be as reticent as his predecessor, Mr. Trichet, to act. Specifically, he could simply begin to aggressively buy sovereign debt . They have not wanted to monetize the debt. They have been hoping that the EFSF will be able to buy the debt and take the load off their shoulders. They may not have that luxury.

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