In less than 24 hours, European Leaders will be gathering in Brussels to decide the future of the euro. By now, everyone knows that the Germans staunchly oppose any type of liability sharing and the chance of changing their minds over the next 2 days is practically zero. This week German Chancellor Merkel took every opportunity to reject the notion of Eurobonds or any type of liability sharing including joint deposit insurance. Not only did she make her stance abundantly clear but to remove further ambiguity Merkel went on to say that she doesn't see it happening in her lifetime. In light of this very public opposition to sharing sovereign credit risk, it would be safe to assume that most investors expect the EU Summit to be a big disappointment. In fact very few EU Summits have resulted in major announcements because these meetings are driven more by politics than economics. For this reason, a compromise from the Germans and a credible blueprint for a fiscal union could trigger a larger reaction in the euro than the disappointment.
Don't Expect a Fresh Low Quite Yet
To be clear, we still expect the euro to weaken if EU leaders fail to convince investors that progress is being made, but disappointing results may not be enough to drive the EUR/USD to a fresh 2 year low below 1.2288. This is because investors will quickly shift their hope over to next week's European Central Bank meeting. If the EU Summit doesn't go well and the markets react negatively to the outcome, everyone will look for the ECB to play the role of the white knight riding into the rescue. Now if the ECB fails to provide any fresh support, the EUR/USD will then collapse more significantly as investors finally realize the gravity of the situation and the impossibility of recovery without an agreement from the Germans. What Europe needs and what EU leaders will deliver are two completely differently issues. We know Europe needs Eurobonds and Guaranteed Deposit Insurance to prevent defaults and bank runs, but the contentious debate around these issues means that all we can expect from EU leaders are the following:
What EU Leaders Will Deliver
- EUR130 billion Growth Package
- Tax on Financial Transactions
- Single European Banking Supervisor
We know there will be at least 2 major announcements on Friday - a EUR130 billion growth package and a financial tax that would be used to pay for future bailouts. Both of these measures were agreed to at the four-way summit between German, French, Italian and Spanish leaders last week. While sovereign credit risk is important, supporting growth is also a critical step to turning Europe around because at the end of the day, the real problem in all of these countries is the high level of unemployment. Details on what the growth package will include should be shared this week along with the announcement of a Tobin tax, which is tax on financial transactions (sale of stocks, bonds and derivatives) that help to raise money for the governments and for future bailouts. There should also be plans to form a single European banking supervisor that oversees the region's biggest banks. All these proposals are quick wins that can be implemented quickly without a change to the EU Treaty. Unfortunately none of these are the solutions that Europe really needs to end its debt crisis.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
