Macro Focus: Europe’s Version of Let’s Make a Deal?

Fri, JUN 29th, 2012

Today’s EU news is big, especially in that it signals leaders understand the problems and are willing to coordinate a response to keep it from spiraling out of control. Likewise, it also suggests that Ms. No-Eurobonds-While-I’m-Alive doesn’t hold all of the cards in this game. Spain and Italy matter. And they have something Greece never had: Weight.

Here’s the quick rundown of the “deal.” Wait. Perhaps we shouldn’t call it that. At this point, they’re more like guidelines.

ESM bailout funds will not subordinate private bondholders, this is good because being put into second and third creditor status has to, some degree, kept private investors out of the capital markets and this decision changes that

ESM bailout funds will not add to sovereign debt loads because they will go straight to recapitalizing troubled European banks as opposed to channeled through the sovereigns

ESM bailout funds may come with little-to-no strings attached, which is good because past Trokia conditions [via govt bailouts] meant austerity [a self-defeating cycle in a recession]

ECB will act as an agent and purchase bonds on behalf of the ESM basically giving the ESM direct access to the ECB printing press

It goes back to what we’ve been saying for many months, for all of their bickering, silliness and divisiveness, EU leaders know/believe that more Europe with a common currency [even with its challenges] is more economically beneficial to the region [and the world] than allowing it to break apart. The challenges are great. No, they’re huge. But the core doesn’t want to give lifelines away for free — a noble pursuit. That said, the costs of dissolving the monetary union are bigger. They’re incalculable. Germany gets that. Thus, markets [most pointedly when in risk-off mode] have consistently underestimated EU leaders’ willingness and resourcefulness to act.

That said, I do think there are a number of hurdles left to leap: German parliamentary ratification and unanimous EU approval, which includes Finland; exact ESM structure and available funding resources; ECB offering support; clarity on the funding assistance chiefly whether there are truly no Troika conditions; the possibility of a required legal makeover to implement these changes. And these hurdles are just top of mind. It’s likely many others will follow.

Oh, FYI – the ECB has a policy meeting on July 5th. Perhaps we get more clarity on their role here, and perhaps we get a rate cut as a sign of their willingness to play ball [1% —> 0.75%]?

What’s more, the ESM itself still must be ratified [although I do expect this to happen] before it can officially begin operations [expected July 9th]. So in other words, at present, this deal is all built upon a bailout facility that doesn’t legally exist yet.

OK. Assuming everything goes to plan: Deal terms receive full EU approval; ESM is officially given the green light; little-to-no Troika conditionality; ESM truly doesn’t subordinate private bondholders with some backdoor clause; and ECB affirms support making its printing press available, the earliest we could see an actual EU single bank regulator [to oversee ESM, mutual banking, etc.] would likely be Jan 1st, 2013. Therefore, the ESM won’t be able to actually start this new plan until then.

Six months is a life time in today’s market climate. Even if we do in fact achieve most of these things [which is my baseline scenario] that doesn’t mean all is now saved today. No. The market will continue to be whipped around over the short-term by headlines out of Europe calling into question details of the guidelines deal.

In addition, still-soft US macroeconomic data will probably continue to do its naughty little part as a stock market destabilzer. For now. Second quarter earnings seasons officially kicks of on — guess what! — July 9th. We will get a better picture of the health of the business cycle then. This is every bit as important, perhaps more so, than any short-on-details “deal” EU leaders can conjure up.

Jason L. Ware, MBA
Market Strategist, Chief Analyst
Albion Financial Group
(801) 487-3700; (877) 487-6200

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