Europe: A Difficult Negotiation

Includes: ERO
by: Angelo Airaghi

After an intense week of negotiations, European leaders are again gathering in Brussels to discuss the sovereign debt crisis. Various issues are on the table and time is short. Financial markets will again be under pressure, if hope fades away.

The euro could stretch until 1.40-1.41, where important lines of resistance meet.

Europe: What is the deal?

Attention is still focused on European struggle, as leaders are meeting in Belgium for a week-long marathon. They will discuss solutions for the sovereign debt crisis, but time is limited and the room for negotiation is narrow.

Differences have already emerged among member states. France, as an example, supports the idea of a banking license to the European Financial Stability Facility. As a result, the bailout fund could use European bonds as a guarantee to receive fresh cash from the E.C.B. With that money, more bonds can be purchased and used as collateral to gather additional money from the E.C.B. The idea does not have much appeal. The E.C.B does not want to start printing a huge amount of money just to cover government deficits.

Nonetheless, a compromise among the 17 members sharing the euro is possible. The EFSF bailout fund could be increased. In this way, it will marginally cover European bonds against losses in case of a default. In fact, under current conditions, the fund could provide loans up to Euro 440 billion, which it is only a drop in the sea of the large European debt. At least, euro 1 trillion might be necessary to begin the work: the recapitalization of banks, the organized default of Greece and the purchase of Spanish /Italian /Portuguese bonds to balance Greece`s propagation. Parliament approval might then be needed.

Will European governments provide that amount of money?

Euro is stretching to the extremes?

An insurance-fund`s solution might also be brought to the table. Troubled European countries will continue to issue bonds, while the EFSF would provide partial coverage in case of a default. Will it work? Investors are looking for safe assets and insurance bonds are not the safest. In addition, more coverage will be needed to insure debts than the 20% anticipated.

In reality, banks could face some problems, if the European governments decide to transfer more Greek`s debt into their balance sheets.

In the coming months, financial institutions would be given the time to raise capital in the private market. However, the troika would have to do the rest, if capital would not be found.

Too many issues must be resolved in a short period of time.

The euro is meeting strong resistance levels at 1.39-1.41. A breakout failure will quickly take the price back to 1.33 and eventually to 1.26. Only a move above 1.4650 could target 1.48 and eventually 1.60.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.