Sunday, May 9, 2010

EU's Shock and Awe

From Bloomberg article:
Jolted into action by last week’s slide in the currency and soaring bond yields in Portugal and Spain, the 16 euro nations agreed to offer financial assistance worth as much as 750 billion euros ($962 billion) to countries under attack from speculators. The European Central Bank will counter “severe tensions” in “certain” markets by purchasing government and private debt...
This is Shock and Awe, Part II and in 3-D,” Marco Annunziata, chief economist at UniCredit Group in London, said in an e-mailed note. “This truly is overwhelming force, and should be more than sufficient to stabilize markets in the near term, prevent panic and contain the risk of contagion.”

Well, this is more like what the doctor ordered. To be honest, even that large of a package by itself may not be enough, because the borrowing needs of the likes of Spain and Italy are much, much larger than that. Still, it's sizeable, and if I read things correctly, the cap is really quite soft because of ECB's upcoming debt monetization.

The Euro is surging righ now, but this is all wrong. There's gonna be QE in Europe as ECB starts buying up sovereign debt and this should hurt the currency over the next few months, especially if the Fed doesn't resume its own debt monetization programs. The bond yields should start normalizing though, with spreads for the PIIGS narrowing substantially and the fligh-to-safety trades unwinding both for the German bunds and US Treasuries.

Currencies can't all devalue at the same time. So there's bound to be some give and some take. Good news for gold bugs, I suppose - but that's a side show. The real issue is what happens to US trade balance now and whether the slumping Euro puts a damper on the nascent US recovery.

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