As Europe teeters, markets hover between hope and fear

Since the crisis began, it has been difficult for investors to position themselves in the investment environment, which has swung up and down. European leaders have tried hard to restore investor confidence, and the recent EU summit in Brussels delivered surprise progress in efforts to resolve the crisis.

In addition to the announcement of a 120 billion euro stimulus package after the first day’s session, European leaders agreed that the existing European Stability Mechanism (ESM) and European Financial Stability Facility (EFSF) instruments could be used “in a flexible and efficient manner” in order to stabilise markets. They believe that the action will potentially cap Spanish and Italian bond yields in the near term, and the European Central Bank will function as an agent of the EFSF/ESM in conducting market operations. Also, a single supervisory mechanism for euro-zone banks is set to be launched by the end of 2012, when the European Union will allow banks to directly recapitalise from the ESM. 

Once the ESM becomes available, the responsibility of recapitalising banks will switch from the EFSF to ESM, with the funds received no longer going through government. Previously, the rescue fund was not allowed to recapitalise directly but had to be transferred via governments, increasing each crisis-hit country’s debt level. 

One more important point is that the lending capacity of the EFSF/ESM is currently limited to 500 billion euros, which, after delivery of some 100 billion euros to recapitalise Spanish banks, will fall to 400 billion.       

Even though the Brussels summit sent some key positive messages to the market, details are lacking. More information is needed on the mechanics and resources of ESM sovereign debt purchases, creditor status of the bond purchases, deposit guarantee schemes and resolution authority. Without it, fear will return to the market. Hence, we still have to keep a close watch on key developments. German Chancellor Angela Merkel and Italian Prime Minister Monti brought brighter news on Wednesday, promising to work together for a solution to the crisis. But the markets were waiting for two developments: at the European Central Bank policy meeting yesterday, the ECB was expected to cut its rate by 0.25 per cent, while the Eurogroup Finance Ministers will meet on Monday.   

 

Duangkamon Phunkaew is a senior dealer in the Treasury Department of Bangkok Bank.