Merkel, Draghi, Rajoy, Monti and the bailouts: What to do? - Round press

In June during the last International Traders Conference in Barcelona, Ed Ponsi said in his speech, 'The Future of the U.S. Dollar,' that the reason Germany doesn't print money is that they still remember the 1-billion mark bill. I've been keeping this phrase on my mind during the last month as I've always believed that money is the tool to make better societies even if governments have to invest more money. But I also think that the current countries' leveraging levels are unsustainable. So I found Ed's idea a clever quote to define the Euro situation.

Germany's Merkel is reluctant to permit ECB to support banks directly but if Europeans finally decide to do it as it was hinted at the latest June summit and on Thursday by Mario Draghi, the process "must be implemented quickly" as Ed Ponsi said in this press round with FXstreet.com. "At the current pace, it could take months or even years and that is what the markets find unacceptable."

Richard Olsen, co-founder of OANDA, commented at the ITC too that "Central Banks are spending all tools they have." If necessary, "what Central Banks will use when things come worst?" In other words, what euro leaders must do to improve market sentiment and to ease borrowing costs across the South European countries?

"An exit from the Euro is growing," said John Kicklighter from DailyFX, speaking about Greece, Spain and even other countries. "But the risk that it confers is so large that we need to give the scenario greater weight when we incorporate it into our trading expectations." Kicklighter believes "a Greek exit is around 60 percent at this point."

In addition, the odds for a full bailout to Spain are growing fast and "Euro-area officials will likely force the member to take a full bailout," comments Kicklighter. "We already have an open promise of up to €100 billion of total support for the country and €30 billion of funds for immediate crises need; and confidence continues to evaporate regardless."

"With borrowing costs at unsustainable levels," states Ilian Yotov from Allthingsforex.com. "I would say the odds are about 99.9%." Market believes that Spain would need more than 600 billion for a full bailout to meet borrowing necessities for the next 3 years. In this way yield pressures would be avoided. "What is more pressing is the timing and the method of implementation," comments Ponsi. "If those issues can be resolved quickly, we could see a recovery in the Euro."

Early on Friday, Spain acknowledged it might require a full bailout from the European Union and the IMF worth €300 billion if its borrowing costs remain unsustainable high, Reuters reported citing an unnamed euro zone official.

According to the report, Spain's Economy Minister Luis de Guindos discussed the issue with its German counterpart Wolfgang Schaeuble in a meeting in Berlin on Tuesday as Spanish 10-year yields rose above 7.6%. The official said Germany wasn't comfortable with the idea of a bailout now, Reuters reported.

The IMF published its Article VI on Spain saying that the economic outlook for Spain "remains very difficult and vulnerable to significant downside risks." Spain's unprecedented double-dip recession will last at least until 2014 and poses a threat to the rest of Europe, the International Monetary Fund said. The Fund estimates that policy tightening will reduce output by 1% by 2014 and that unemployment will also rise.

Meanwhile, the Fund expects the Spanish economy to contract by double of previously estimated in 2013. They expect a 1.2% GDP drop in 2013 (previous estimate: -0.6%) and a 1.7% contraction this year (-1.5% previously estimated).

For the time being, ECB’s President Mario Draghi said in a speech in London on Thursday that the European Central Bank would "do whatever it takes to preserve the euro," and "it will be enough" to solve the situation. These words relieved market sentiment and the risk has been put in on mode with the Euro trading above 1.2300. Spanish 10-year bonds traded lower on the back of Draghi's comments. The Spain's Premium risk declined to the current 534 bps with the 10Y bond fell from euro-era highest at 7.73%, reached this week, to the current 6.77%. Italian premium risk eased to 453 bps with the 10Y bonds declining from Wednesday's 6.65% to the current 5.96%.

Despite the fact that Spain's spread decline by more than 40bps on Thursday, concerns on Spanish ability to support current borrowing costs remains as William Gross from PIMCO says, "Spanish yields drop 50 basis on Draghi. No matter. They need 400 basis more to remain solvent longer term."

"Greece, Ireland and Portugal were all pushed into bailout programmes shortly after their long-term borrowing costs exceeded 7%," thinks Megan Green, Head of European Economics at Roubini Global Economics. "But there is no magic number above which borrowing becomes unsustainable. In theory a country could survive if it made a bigger fiscal adjustment so that it had more money to pay down its debt."

"The Spanish government is going out of its way to avoid it [bailout]," continues Greene "In part this is because of concerns that it will be unable to regain market access once it loses it by borrowing from the EU bailout funds. But a delay is also important to the rest of the Eurozone."

In this line, "if the market is already on the path of avoiding risky investments," believes Kicklighter, "they will make a concerted effort to avoid Spain as they have seen too many repeat problems with troubled Euro countries in the past."

"The question is where the estimated 300 billion euro needed for Spain will come from?" rhetorically asks us Ilian Yotov. "There is not in practice enough bailout money for those two countries [Spain and Italy] now," remarks Greene.

Meanwhile, institutions like Citi, in the voice of its Chief Economist Willem Buiter, believes Greece is likely to leave the Eurozone over the next 12-18 months, with chances of 90%: "Our base case is for prolonged economic weakness and financial market strains in periphery countries, spilling over into renewed recession for the euro area as a whole this year and the next”, stating the increased chances from 50-75% now to 90%, most likely in the next 2-3 quarters.

On the other hand, "reports leak from the Spanish government that the prime minister is considering "putting on the table" the option of a withdrawal from the euro," remarks Yotov. And Buiter affirms that the crisis won’t be solved after the “Grexit” as Spain and Italy are expected to “form of troika bailout for the sovereign by the end of 2012”.

So what the leaders must do is act fast and quickly on banking union and allowing ECB to recapitalize banks directly. "If the Eurozone wanted to make sweeping strides towards stabilizing the Spanish troubles," says Kicklighter, "they could fast track the rescue of the nation’s banking system and offer us clear details about the size of the program and the conditions"

"If they wanted to take it even further," continues Kicklighter, "they could quickly adopt the Banking Union that would set the foundation for using the ESM to bailout banking system and further to purchasing government bonds (to stem both sovereign and bank issues)."

Providing the ECB with bank license "could be a good solution to the problem," underlines Yotov. "Give the permanent ESM fund a banking license which will allow it to borrow from the European Central Bank and will increase its firepower."

In other words, paraphrasing a fridge magnet that a friend gave me: "Euro got me into this mess and as God is my witness, Euro will get me out of it."

Experts answer this questions:

• Spain Premium risk is increasing despite the country's efforts and now several regions have announced that they would ask for bailout in the coming months. What should Spain do to calm markets and relieve its debt costs? What should the Eurozone do to help Spain?
• What are the odds for a full bailout to Spain?
• Moody's has warned EZ core countries on area breaking possibilities. Do you think it is possible for Greece, Spain and even other countries to take the exit door?

John Kicklighter, DailyFX.com

• If the Eurozone wanted to make sweeping strides towards stabilizing the Spanish troubles, they could fast track the rescue of the nation’s banking system and offer us clear details about the size of the program and the conditions. If they wanted to take it even further, they could quickly adopt the Banking Union that would set the foundation for using the ESM to bailout banking system and further to purchasing government bonds (to stem both sovereign and bank issues). That is the ideal, however, and it is very unlikely to happen at this current stage of the Euro crisis. The risk levels for the Spanish government and banking financial systems continue to rise due to the general decline in investor sentiment (which weighs on the most troubled players) alongside the growing cost with the regional governments admitting liquidity issues while the country’s rescuers drag their feet.
• Should risk aversion continue and further exacerbate Spain’s financial situation, Euro-area officials will likely force the member to take a full bailout. We already have an open promise of up to €100 billion of total support for the country and €30 billion of funds for immediate crises need; and confidence continues to evaporate regardless. If the market is already on the path of avoiding risky investments, they will make a concerted effort to avoid Spain as they have seen too many repeat problems with troubled Euro countries in the past.

"I believe a Greek exit is around 60 percent at this point."

• An exit from the Euro is growing, but the risk that it confers is so large that we need to give the scenario greater weight when we incorporate it into our trading expectations. We have seen recent headlines about a myriad of banks taking steps to build contingencies on a Euro breakup (or individual country exit) and many are also providing their assessment of probability in client notes. Personally, I believe a Greek exit is around 60 percent at this point. A total recovery of risk appetite could halt the threat; a blind dedication to austerity with some group give for growth-forward policy could drag it along; or the fast activation of the ESM as a bailout source can increase the crisis fight fire power. All three considerations carry many obstacles and would not likely come online quickly enough. While a Greek exit is probable, others following in its wake is less likely. Using the euro bestows considerable benefits on its members; and they wouldn’t give that up readily – otherwise they would have done it long ago.

Ilian Yotov, AllthingsForex

"I don't think Spain can do much- the ball is now in the EZ leaders' court because it is pretty much a given that Spain will need a bailout."

• I don't think Spain can do much- the ball is now in the EZ leaders' court because it is pretty much a given that Spain will need a bailout. The question is where the estimated 300 billion euro needed for Spain will come from? ESM is still not active and there is about 160 billion only left in the temporary EFSF bailout fund. The newly-proposed idea today could be a good solution to the problem- give the permanent ESM fund a banking license which will allow it to borrow from the European Central Bank and will increase its firepower.
• With borrowing costs at unsustainable levels, I would say the odds are about 99.9%...
• I am not excluding the possibility of Greece or Spain exiting the euro-area. Especially when we see estimates such as the one from the Ifo institute that if Greece were to remain in the euro it would cost German taxpayers as much as EUR 89 billion, while reports leak from the Spanish government that the prime minister is considering "putting on the table" the option of a withdrawal from the euro.

Ed ponsi, FXEducator LLC

• The process of bailing out banks directly must be implemented quickly. Right now, the mechanism for setting up a banking regulator for all of Europe is holding up the process. At the current pace, it could take months or even years, and that is what the markets find unacceptable. An immediate effort must be made to facilitate this process.
• The odds of a full bailout for Spain are very good. What is more pressing is the timing and the method of implementation. If those issues can be resolved quickly, we could see a recovery in the Euro.

"I'm concerned about Merkel's eroding popularity in Germany."

• I don't think Greece, Spain, or any other countries will voluntarily leave the Euro. I'm concerned about Merkel's eroding popularity in Germany. If Merkel were to be replaced, I'd be very concerned about an even more hard-line approach from Germany.

Other opinions:

Megan Greene, Economistmeg.com & Roubini Global Economics

• Greece, Ireland and Portugal were all pushed into bailout programmes shortly after their long-term borrowing costs exceeded 7%. But there is no magic number above which borrowing becomes unsustainable. In theory a country could survive if it made a bigger fiscal adjustment so that it had more money to pay down its debt.
• Spain is not in the same position as Greece and Portugal in particular because it is nowhere close to running out of cash. It has a long average debt maturity, so its debt will not be raised at such high rates all at once.

"Were Spain to be taken out of the markets, investors would focus on Italy, which would soon also need a bailout."

• Though Spain may be hogging the limelight now, Italian borrowing costs are only slightly lower. Were Spain to be taken out of the markets, investors would focus on Italy, which would soon also need a bailout. It is an open question whether the EU funds and IMF have