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EU Scares Market into Support of Failing States

|Includes: ProShares UltraShort Euro ETF (EUO)

The European Union announced an unprecedented $962 billion bailout package that will provided to support failing European states, purchase government and private bonds, and possibly to support the euro as a currency in the foreign exchange market. As a result, the EU has effectively scared the markets into supporting its failing states, according to some analysts.

These actions led to a predictable rise in the value of the euro, lower bond yields, and higher European equity prices as bears and short-sellers scrambled to exit and cover their positions. Short sellers bet on the decline in the value of a security by borrowing and selling it immediately while promising to buy it back in the future – ideally at a lower price.

The EUR/USD currency pair surged past 1.30 during the overnight Asian session, while futures in the U.S. are pointing to a 400 point rise at open. Meanwhile, Greece and Portugal spreads against the German bund have dropped significantly, returning to more normalized levels and the cost of insurance against default for many euro zone nations has become relatively cheap.

The EU’s bailout package is large enough to cover Spain’s and Portugal’s gross issuance of public debt for the next two to three years, which removes near-term pressure to dramatically cut spending. As a result, bets on near-term defaults have been virtually wiped out and concerns about the euro zone breaking up have been eliminated for now.

However, many economists are concerned that the EU may simply be delaying their budget and spending problems.

“Like taking an ecstasy pill, the EU’s bailout has made things seem great in the near-term,” said Mark Taylor, a European risk analyst. “Unfortunately, greater problems could lie on the horizon, unless real changes are implemented; and with slow economic growth and a population accustomed to a heavy state spending, that could prove very difficult.”

How long the high will last depends largely on the private sector’s ability to resume economic growth, according to many economists. If successful, it could be decades before another day of reckoning, but if not, Europe could find itself in the same situation in the nearer term. In the meantime, investors can expect a sharp rise in the EU as bears are scared off… for now.

Disclosure: No positions