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A last-minute deal was reached, but structural problems remain unresolved in Europe. Recessionary winds are blowing and the E.C.B. might cut rates on Thursday. The Euro is reaching an important juncture. A break it/make it scenario is possible.
Europe: Here is the package
“Alea acta iest”! The die has been cast in Brussels. Nonetheless, it was not an easy hand. An agreement was reached only in the early hours of Thursday. Markets received a boost from the positive news. Incertitude remains over the capacity of all components to achieve their targets. Italy and Spain are on probation, while Greece problems are not resolved. Fitch Ratings considers the Greek debt exchange a default. However, three steps forward has been taken to resolve the European debt crisis. First, the rescue fund could be increased up to euro 1 trillion. It should take some of the stress off the E.C.B., which is still buying Spanish and Italian bonds. Nonetheless, the EFSF’s program will not be able to be started soon. Will it work? Italy and Spain must continue with fiscal consolidations. Otherwise, the fund can not cover a bailout of either one of the two countries.
Second, by January 2012, the private sector holders, European banks manly, should accept a 50% cut of Greek government bonds. Details have not been provided yet, but about euro 100 billion will be removed from the Greek’s debt. European governments and the I.M.F. (they own a large portion of the debt) are excluded from the write-down. As a result, the Greek’s debt to G.D.P. ratio stays way above 100% and is expected to be reduced to 120% only by 2020. Some economists consider the cut not enough to relive the Greece’s debt burden. In fact, Greece would need a series of good years to provide the surplus necessary to cover the debt. In addition, the deal is voluntary and must still be signed by the banks to become reality. Second thoughts are p
Recessionary winds are blowing.
Lastly, European banks must achieve a 9% threshold (bank's core equity capital/ total risk-weighted assets) by June 30, 2012. The right percentage has not been established yet. However, according to some sources, banks would need up to euro 300 billion as a worst case scenario. It contemplates a Greece default and a recession in Europe. The European Banking Authority has instead estimated, after a new stress test, euro 106 billion. Who is right? The capital must first be raised in the marketplace. Governments and the EFSF have to help, in case money is not reached privately. Banks have already declared they prefer to narrow their balance sheet, instead of rising capital at such low prices. If this would be the case, the European economy could contract further, considering financial institutions are the main resource of funding in Europe.
In effect, recessionary winds are blowing in the continent. In October, for the second month in a row, the P.M.I. has declined below the benchmark of 50 to 47.2. Both the manufacturing and service sectors are in red. Firms are careful about investing. Hiring is on hold. The sentiment is expected to contract in the coming months as well. The new order index, which anticipates future activity, fell to the lowest level since 2009. Economists are now forecasting growth to be near 0 in the last quarter of the year. The E.C.B. should cut rates by 25/50 basis points by the end of 2011.
The Euro/USD has reached an important juncture at 1.42/1.43. Various lines of resistance meet at current levels. A breakout failure could quickly take the price to 1.33 and eventually 1.26. A swing above 1.4650 will instead reinvigorate the long term trend and lift the price to 1.49 and possibly 1.52.
Angelo Airaghi, www.ProfitsOn.com
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