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Positions in Europe: Short EUR-USD (FXE)

Today’s statement from the EU Summit confirms our position that the Eurocrats wouldn’t reveal anything close to the market’s hope of a “Bazooka” to address the region’s sovereign debt and banking imbalances. Now it appears France’s Sarkozy will be kneeling at China’s doorstep (followed by Germany) over the next two days to plead for funding.  A mismanaged European soap opera this is indeed…

In fact, today’s decision concluded so little that it will likely be weeks before we get some form of a concrete resolution(s). [For our position going into today see our post on 10/24 title “European Risk Monitor: At the Halfway Point? No Chance.”]   

To read the mere 3-page conclusion of today’s meeting click on the link below. (You may need to copy and paste the link into your browser to view): http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/125621.pdf

A few pressing items that are clearly missing or not appropriately defined in today’s statement include:

  • Bank Recaps -- How much must European banks raise to recapitalize themselves? No measures were offered in the very likely case that not all banks can accomplish this. If the market is going to feel comfortable with this “plan”, there will need to be firm mandates on the size, scope, and timing of these recapitalization, as well as secondary plans should the banks not be able to accomplish the recap themselves. What are the nationalization strategies? How will the EFSF contribute to support banks when such measures aren’t clearly outlined, and more importantly, the facility is undercapitalized to support banks and sovereigns across the region at its present level?  The web of cross-country exposures and derivative impact makes answering these questions all the more difficult.
  • EFSF -- Is the EFSF going to be enlarged? And how? Through ECB contribution, member states posting more collateral against the EFSF, increased IMF contribution? We’re of the opinion that so long as the ECB is not going to directly support bolstering the EFSF, we don’t see any hope of expanding the facility in short order, unless the Chinese ride in on a white horse. The most recent example is the grave effort it took (months) for member states to ratify the July 21st EFSF, which didn’t even boost the current size of the facility.

Interestingly, Germany’s Bundestag approved the expansion of the EFSF today, however the mandate stated that the EFSF cannot be financed via the ECB and the ECB will no longer need to buy bonds on the secondary market. We’re left scratching our head on the first point. To the second, it’s clear that the ECB expected the SMP (bond purchasing program) to be temporary. However, and while the SMP cannot solely blanket sovereign risks (think Italy and Spain in particular), it’s in no one’s benefit for immediate termination of this facility.   

  • Greek Haircuts --There’s still no specific guidance on the haircut international lenders should assume: 21% (as proposal 3 months ago) or closer to the 50-60% range supported by the German camp and whispered by the IMF this morning?

Any haircut on Greek debt will be a technical default, so it’s clear Eurocrats will push out and tip-toe around the subject to define it in all terms other than what it is to shield issues around the constitutionality of a default within the Eurozone. Remember, there’s no specific language that provides guidance for debt default/”forgiveness” in any of the major treaties.   


Matthew Hedrick

Senior Analyst