Trader Talk

New European Agreement: Good but Maybe Not Good Enough


The statement out of Europe says the leaders will be working toward "a new fiscal compact and strengthened economic policy coordination," but the failure of the U.K. to sign on means that any treaty will likely be outside the EU. It will essentially be a multilateral agreement. It's not clear whether the institutions set up to service the EU — or the euro zone — will be able to service this new agreement.

In Europe, 26 of 27 countries have signed on, including all 17 members of the euro zone. Only the U.K. has said no.

The basic concept: Balanced budgets, with specific rules to be introduced in the constitutions of the member states. What's a balanced budget? Deficits below 0.5 percent of gross domestic product (GDP) , but the rules can be broken. Members that run deficits greater than 3 percent of GDP will face "automatic consequences," but these are not clearly defined. Countries will have to announce how much debt they are taking on.

The Court of Justice, which rules on legal issues in the European Union, will certify that the new rules are enshrined at the national level. Two problems: 1) the Court of Justice is an instrument of the EU and it's not clear they will have the legal authority to make such a ruling if the treaty is concluded outside the EU; and 2) there is no supranational enforcement mechanism for countries that violate the rules.

Why is the U.K. the odd man out? Because talk of integrating labor, tax, and financial laws makes the U.K. nervous, including talk of a financial transaction tax. That is a deal breaker for the U.K., which very much needs revenues from the City of London.

The U.K. may be the odd man out, but Germany's Angela Merkel appears to have gotten much of what she wanted. Her one concession: Giving up the demand that the private sector share in any of the pain. Private debt holders will not take the haircut they took in Greece in other negotiations.

Key takeaway: This will not likely be an EU treaty. To get an EU treaty, you would need all 27 countries to sign on — without the U.K. it can't be done, even assuming all 26 will approve. (Irish leaders have implied they will need a referendum to approve a new treaty; Irish voters have rejected EU treaties twice, only to change their minds later).

And what about the man in the middle, Mario Draghi, head of the European Central Bank ? "It is going to be the basis for much more disciplined economic policy for euro-area members," he said. Whether that will be sufficient to increase bond buying is not clear: He certainly backed away from that yesterday.

Other provisions:

1. The European Stability Mechanism (ESM), the permanent facility to provide lending to euro zone countries that is supposed to replace the European Financial Stability Facility (EFSF) , will be brought out in July of 2012, a year earlier than anticipated. A super-majority of 85 percent will be sufficient to provide loans, rather than requiring all members to agree. The firepower of the fund remains at 500 billion euros ($667 billion).

2. Euro zone members will give as much as 200 billion euros ($267 billion) to the International Monetary Fund so they can help out, presumably lending the money to euro zone countries.

Elsewhere: Stocks slump before the bell on lowering of guidance.

1. E.I DuPont Nemours fell more than 5 percent in pre-market trading after cutting its full-year earnings outlook to $3.87 a share to $3.95 a share, from $3.97 a share to $4.05 a share. The chemical company attributes its decreased expectations to some customers destocking and overall slowing economic growth. Additionally, DuPont notes a further softening of demand in consumer electronics, and the housing and construction markets. Despite lowering guidance for fiscal 2011, the company reported it expects earnings growth in 2012.

2. Texas Instruments down more than 5 percent pre-open after lowering fourth-quarter guidance on weak demand across markets, except for its wireless applications processors that are used in smartphones. The semiconductor maker announced after the market close yesterday that it expects to earn between 21 cents a share and 25 cents per share in the fourth quarter, down from an earlier forecast of 28 cents a share to 36 cents a share. Texas Instruments slashed its revenue forecast to $3.19 billion to $3.33 billion, compared with a prior range of $3.26 billion to $3.54 billion.

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