European leaders appear to have achieved more in their two-day
Brussels summit than many in the market expected and the result is
showing up in markets across the board. Details on the Euro-zone
deal are still sketchy, but they have generated enough optimism to
offset the relatively soft consumer spending data for May on the
home front.
Is it the end-point on the Euro-zone question that the market
had been looking for all this while or we are seeing 'irrational
exuberance' that will soon subside once investors realize that
hardly anything has changed on the ground at this stage? My take is
that the market's optimism today is not misplaced as the European
leaders have announced their intention to pursue substantive
changes. This is by no means the end point that everyone has been
asking them to announce. But it is nevertheless a good-enough start
that puts the region on track for shared liabilities and a banking
union down the road.
Markets are forward-looking pricing mechanisms; they look ahead
in putting a price tag on assets. So we don't need each and every
broken piece of the Euro-zone framework fixed before asset prices
will reflect the 'fix'. A credible enough roadmap would suffice -
and that's what we are seeing in the market today.
Leaders agreed to break the 'feedback loop' between
undercapitalized banks and their distressed sovereign regulators by
letting the permanent bailout fund directly inject capital into the
banks. They will do that after they set up a common Euro-zone wide
bank supervising institution. They also agreed to let the bailout
fund directly purchase government bonds of member countries without
requiring them to go through onerous austerity programs like what
Greece, Ireland, and Portugal endured. With respect to the
immediate needs of Spain, they agreed to not give priority to their
loans over existing government debt and even let the currently
agreed bank bailout loan eventually transferred to the common
bailout fund. There is also a growth centric program through
increased spending that had been agreed to in pre-summit meetings.
All in all, they have set the process in motion to create a banking
union, kind-of mutualize debt and agree on a sequencing of these
measures.
This doesn't mean there wouldn't be disappointments down the
road; you can almost guarantee there would be. National
politicians, who have thus far been behind the curve on everything,
will need to sell to their citizens why they need to sign off on
ceding their fiscal sovereignty to Germany. Many European nations
don't exactly have fond memories of the last time Germany was their
overlord. Bottom line, Europe is not fixed yet, it's a very long
journey. But they made a good start today.
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