European Sovereign Crisis – Averted or just Postponed?
The long awaited comprehensive plan, that Europe aspires to contain the two year old euro zone crisis with, came to light in the early hours of Thursday with investors greeting the signs of ostensible success amid rising optimism. The European „bazooka” foresees a nominal discount of 50% (€100bn) on notional Greek debt held by private investors, who will be offered a sweetener of €30 bn in return. In addition, the EFSF will be scaled up about four to five times, with estimates of its firepower ranging from €1tn to €4 tn, either by offering insurance to the purchasers of euro zone debt or through a SPI that aims to attract investment from China and Brazil. Extra pressure was put on Italy to balance its budget. Banks are expected to seek private capital or, if necessary, get government support with the EFSF serving as the very last rescue vehicle.
In plain English, policy makers are buying time. Troubled European countries are expected to undergo further austerity and debt improvements, which will continue to put downward pressure on growth and ultimately worsen the fiscal picture, although Greece has already proven that this is not really a viable solution. Bondholders will take a haircut on the debt they own, but they will be capitalized in return. For the time being there is no agreement of any kind of fiscal union. A larger EFSF instead aims to stem the bleeding and avert the worst case scenario, i.e. the European version of Lehman Brothers, as it ensures that European banks will not be allowed to fail.
Despite the lack of details and the lack of surprise it looks like the deal manages to temporarily address the Eurozone Ice-Nine liquidity issue. In reality this is just more of the same, but in greater size. Considering the sum of money Italy and Spain require and adding to that other potential future bailouts, Europe will be faced with the same problem again, unless the fundamental flaws in the economic union are resolved. Until Europe finds a way to resolve the imbalance caused by the single currency, we had better not celebrate the end of the crisis, but for the time being we can breathe a sigh of relief.
As the single currency seems to be fundamentally driven at the moment, it may continue to pare the losses from the previous months as policy makers are expected to increase their efforts until the agreement takes its final shape in the next few months. The euro-dollar is currently hovering around a fresh monthly high of $1.4145,(61,8% Fibonacci retracement from the 2009 high to the 2010 low). Should the euro break above that level putting risk appetite back on table, it could see resistance at August high of 1.4525.
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