BarroMetrics Views: The ‘EU Rally’
Following the EU Summit agreement, I thought it opportune to look at Friday’s impressive stock market rally from a fundamental and technical view. For me, the fundamentals provide another tool to define ‘the context’ of a trade.
First let’s see what was agreed upon……
- The ECB will now have direct supervision of eurozone banks;
- There will be eurozone buying of bonds via the rescue funds – an important provision is to waive the creditor status for these funds in holding Spanish debt i.e. the early bond holders of Spanish debt will not receive preferred status. This makes easier marketing of the new debt.
- ESM (bailout successor of the EFSF) will be able to inject capital directly intokthe Spanish banks.
Second, let’s turn to my interpretation…..
Pete Steidlmayer taught me to classify events into:
- Expected (little impact on markets)
- Surprise events (strong impact on markets without effecting the underlying conditions)
- Unexpected events (strong impact that change the underlying conditions. The change is perceived by only a few traders).
In my view, this was a surprise event.
The reason I say is the measures have to garner German support and they have to pass the German parliament. Despite Merkal’s press conference stating that assistance will be accompanied by stringent conditions, the public Spanish and Italian announcements suggest that they view assistance as a forgone conclusion. Given the negative German public and parliamentary response, that is a dangerous assumption to make.
It’s true that the German Parliament has approved the ESM. But what has not been approved has been the conditions under which ESM will provide the loans – something that Merkel has said will be placed before the ruling body.
In addition, the ESM approval is likely to face a constitutional challenge. This challenge even if unsuccessful, will make unlikely the stated July implementation of assistance to Spanish Banks. In the past constitutional challenges have been heard quickly – usually in a matter of weeks.
And even if the measures pass, the question still has to be asked: how will they be funded? Italy’s problems are too big for any nation. The only long-term solution is for the ECB to be given the power to print its own currency – and I just can’t see Germany backing that measure.
This being the case – the EU Summit produced a ‘surprise event’ – the key question is ‘what are the underlying stock market conditions’? I’ll deal with that question tomorrow.