As we head into another busy week of headline driven trading, these will be the 5 main topics of conversation, news coverage, and debate to come out of Sunday’s EU Summit which will drive the narrative for this week.
The 5 keys from the Summit, in order of importance are:
1. Two Main Options for EFSF Use in Bond Markets
The EFSF – with its 440 billion war chest – will try and restore confidence in bond markets by one of 2 options. The image to the right shows that the 440 billion in the EFSF is not enough on its own to cover the needs of bailing out both Spain and Italy, therefore some way is needed to stretch its resources.
One is to guarantee government bond sales, something we have been hearing about all of last week.
The EFSF would ensure the first 20%-30% of losses on bonds from periphery countries. That could mean the EFSF can leverage around 5 times every euro it puts in.
While a guarantee of initial losses should help entice capital to buy bonds, there are inherent problems here as well, including how does a country like Italy self-insure itself through the EFSF and concerns that there will be a two-tiered European bond market.
The second option is to set-up a self-insured EFSF fund – a special purpose vehicle – that would attract outside investment in troubles bonds. The main question here would be what size such a SPV would be and who its intended investors are? One answer may be the IMF, which may be looking to play a bigger role in trying to alleviate the pressure of the Euro-zone sovereign debt crisis from global financial markets. A SPV boosted the the reserve of the IMF may be one way to help put more money into the bailout coffers.
You could also see both options being used in parallel. Again, we have to wait till Summit #2 on Wednesday for further clarification. Expect headlines around the EFSF role in propping up periphery secondary bond markets to drive market action.
2. No Forces Restructuring of Greek Debt, Voluntary Bank Involvement
Key in going forward for the resolution of the Euro-zone sovereign debt crisis is making sure the Greek debt load is sustainable. That means a significant write-down for bondholders of Greek debt. In the July 21st Summit Greek bondholders – banks and other large financial institutions – agreed to a voluntary 21% write-down. The demand from politicians now – especially in Germany – is a 50% haircut, but the bondholders participation will not be coerced, but will still remain voluntary.The latest from Bloomberg, says banks and other bondholders have agreed to 40%. A bigger write-down would change the situation in Greece from one of insolvency to one of liquidity and can help bring more reassurance to markets. Where politicians and banks come together on the issue of haircuts remains an uncertainty, and leaves question marks as we go forward to Summit #2 and maybe even beyond. Watch this to drive headlines in the first half of the week.
3. Bank Capital Needs at 100 Billion Euros, EFSF as Last Resort
The size of the bank recapitalization plan was put at 100 billion euros, and the EFSF will be used only as a last resort after banks own efforts and national efforts fail to raise the funds.
Bloomberg: Bank capital needs — estimated at 100 billion euros ($139 billion) by a person familiar with the deliberations — will be met first by banks themselves, then by national governments, the European agreed. Only when national efforts fail can governments tap the main 440 billion-euro European Financial Stability Facility for cash tochannel to banks.
This too sounds like it will take some while to get fully sorted out, which would be OK if a market panic did not strike in the interim. For the most part an disorderly default from Greece seems less likely now than earlier in September, but still how these capital raising efforts go will be important for confidence in the markets around the health of the European banking sector.
4. No ECB Quantitative Easing
Germany managed to make sure that the EFSF would not be given a banking license and be able to borrow directly from the ECB. That would have opened up the door for the EFSF to gain additional funding, an approach France sought but was anathema to Germany and the central bank’s outgoing President Jean-Claude Trichet.It essence that would open the door to the ECB using quantitative easing. Printing money in order to buy bonds, which is going to be one of the main responsibilities of the EFSF now that it’s July 21st changes have been ratified by all 17 euro-zone parliaments. While the Fed, and the Bank of England, and the Bank of Japan get to use quantitative easing, the ECB and Europe will not take up this monetary tool.
5. Screws Tighten on Italy’s Berlusconi
Finally, France and Germany, put the pressure on Italy to do more to reassure markets.From Financial Times: “Germany and France have turned on Italy to demand further action to boost growth and reduce its huge debt. Angela Merkel, the German chancellor, and Nicolas Sarkozy, French president, held tough talks with Silvio Berlusconi, at the start of the day-long summit in Brussels, insisting that he take more radical measures to restore the trust of investors. Confidence in Italy’s public finances is critical to preventing the spread of the Greek debt crisis across the eurozone, but France and Germany are worried that Mr Berlusconi is not taking tough enough measures.”
We have seen Italy backsliding on austerity measures, first agreed to to get the ECB to buy its bonds during a period of speculative attack. Burlesconi’s popularity in Italy is faltering and politically he barely survived a vote of confidence in Parliament. While measures to spur growth would be celebrated by the people, the recent formula to control debt has been bouts of austerity, which usually work to stunt growth.
We’ll see if there is any movement on the part of Italy and in the meantime we have to monitor Italy’s bond yields for any extended rally.
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