Post EU summit euphoria has been wearing off through the Asian market as market participants opted to readjust extremely overbought conditions in risk assets across the board.
The week ahead is expected to shed a light on how the market will dissect the latest EU proposals, awaiting for further details from Germany and its effects. On Monday, a way to interpret the sustainability of the current upbeat mood will be thu Spanish and Italian bond markets.
The consensus about the pledges made in the EU summit, as indicated by the massive exodus of USD long positions late last week, is that the EU took important sensible steps, although just one of many; while the solution is still is nowhere to be found, it has certainly bought time for EZ leaders.
One of the major worries seems to be on the limited size and bond-buying thru the EFSF/ESM. Other concerns include ECB's role, getting the Eurozone parliaments to approve pledged in ambitious short time-table.
German press has been critic with chancellor Merkel for giving too many concessions to peripheral European countries. While a move towards a banking union is positive for the interests of Germany and other surplus countries in Europe, the fiscal union remains with little progress.
Greece seeking better conditions from EU
Another issue emerging on the weekend is the consideration of Greece to ask for direct local banks funding through the European Financial Stability Facility (EFSF), despite the recapitalization of Greek lenders was pre-agreed to be part of the latest rescue package.
According to Greek news outlet Ekathimerini: “The issue was discussed, according to reports, during a meeting at the Prime Minister’s residence in Athens on Saturday evening, ahead of the visit of the representatives of Greece’s creditors from Monday.”
Talks focused, according to Ekathimerini, “on the negotiations with the creditors’ inspectors and the acceleration of privatizations that would send a message to Europe that the new government is determined to proceed decisively with reforms.”
Spain's Q2 GDP to be worse than Q1
Spain said over the weekend that its economy will contract in the second quarter more than what already did through the first quarter, a fresh reminder of the challenging times lying ahead for the Spaniards.
According to Spanish economy minister Mr. Guindos: "Data for 2Q show contraction was slightly superior to that of 1Q. The deterioration is not very significant. Spain remains totally committed to austerity. The EU summit intensified European project, sent message of solidarity. Spain must show public finances, services are sustainable."
Merkel and Draghi stress EU funding recipients must meet conditions
During the second day of summit talks EU officials agreed that the rescue for Spanish banks will be transformed into direct recapitalization, as soon as the EU permanent bailout fund, the European Stability Mechanism's capacity is extended, allowing for such a move. This will happen when the ECB takes over as the Eurozone banking supervisor.
EU sources affirm that the change is supposed to take place soon, as 14 out of the 17 national central banks in the Eurozone are now holding supervising powers. Afterward the ESM will be able to recapitalize banks directly, allowing the financial institutions to repay their respective governments for earlier loans. This will happen in the case of Spain, which will receive rescue money before it can be granted directly.
EU officials assure that this measure will reduce the impact of the loan on the recipient country's deficit practically to zero.
Nevertheless, Angela Merkel told reporters in Brussels today that the fact that the ESM will be capable of direct recapitalization of distressed banks does not mean that countries taking advantage of such aid are exempt from meeting certain conditions.
According to the German Chancellor the Troika will not be involved in the recapitalization of Spanish banks. The same applies to Italy, in case the country also asks for bailout money. Only the European Commission and the ECB will take part in the operation, and not the IMF.
Meanwile, on Friday ECB head Mario Draghi expressed his satisfaction with the short-term measures agreed upon at the EU summit, although he also stressed that the Member States which receive EU rescue funds should strictly fulfill the required obligations.
Draghi was especially satisfied with the fact that the ESM will have the capability of granting direct aid to the countries in need.
Acording to the Danske bank team of analysts: “The Summit result is by no means even close to be the solution that can end the debt crisis, but it is reminder that there still is commitment to save the euro project among the political leaders in euro area. It continues to be our main scenario that EMU leaders will do what’s needed to keep the euro together as the cost of a break-up will be enormous – not least for Germany. High uncertainty will likely prevail for a long time, though.”
EU agrees banks recap thru aid funds
It seems there is finally a deal by Eurozone leaders to drastically restructure the recently approved Spain’s €100bn bank recapitalization plan, allowing banks to tap the EFSF/ESM directly.
After hours of deadlock, the agreement finally arrived among the EU leaders around 5am Brussels time, in a reportedly very tense ambient. It was an unscheduled emergency meeting, forced to be called by the EZ growth pact boycot from Spain and Italy, that were demanding the continent's permanent bailout fund to recapitalize struggling banks or they wouldn't accept a Euro €120 bln growth pact.
EU President Herman Van Rompuy said banks can be recapped directly with aid funds, calling it a "breakthrough". However, changes will not occur immediately, as leaders have first to agree on the set up to a joint banking supervisory body led by the ECB, expected in December.
Van Rompuy said the proposal ‘needs unanimity’ and would only occur under ‘strict conditions’. A general long-term plan for a tighter budgetary and political union is also agreed. Van Rompuy added that a first report on euro road map integration will be issued in October.
Bloomberg also reports that dropped a requirement that officials meeting in Brussels agreed to drop the condition that emergency loans to Spanish banks give their governments preferred creditor status. That means that ESM loans to Spain to shore up its banks won’t have senior status, likely to help ease fears of Spanish government bondholders.
According to Sean Callow, currency analyst at Westpac: "Agreement has been reached to allow the bailout funds EFSF and ESM to be tapped by countries that aren’t formally signed to lending programs which have strict conditions (Italy and Spain come to mind!). This is a clear backdown by Germany despite Angela Merkel now publicly welcoming the decision. What has yet to be specified is what conditions will apply – surely Spain can’t just tap the fund at will?!"
The Euro has passed through the roof, peaking around 1.2625 after trading on a extremely soft tone below broken support 1.2450 for almost 24h.
"So definitely some good news for risk markets here though it is not the “big bazooka” – the EU leaders did not place stress on the possibility of Euro bonds (Italian PM Monti tried to talk it up though). EUR/USD should indeed be higher, though the scale of the bounce, from 1.2450 to as high as 1.2628, has obviously been accelerated by the huge overhang of EUR shorts and dismally low expectations for the summit" adds Mr. Callow.