The latest eurozone bailout plan delivered an impressive one-day rally but it’s not going to be the catalyst for the next QE-fuelled bull market.
The latest agreement
Following last week’s two-day EU summit the leaders of the eurozone stayed up all night in order to agree a radical new bailout plan aimed at resolving the region’s three-year old debt crisis.
The leaders from the seventeen nations agreed to ease the terms for future bailouts, set up a supervisory system for eurozone banks (which will form the basis of a full banking union), and change the eurozone bailout rules to enable banks to be recapitalised directly without the money going via governments.
Arguably the most significant aspect of the agreement was the concession made by Germany’s Chancellor, Angela Merkel, to allow the eurozone bailout fund to provide money directly to troubled banks.
Under the agreement the European Stability Mechanism (ESM) will use taxpayer’s money from across the whole eurozone to directly recapitalise eurozone banks. This will not only help to prevent banks from going under, it will also reduce their borrowing costs and help to restore confidence.
Despite the agreement on the use of the ESM, several problems remain. The permanent bailout fund can only be used once a euro area bank supervisory mechanism has been established, and we know from Mrs. Merkel that it could take “several months, or perhaps a year” to setup.
Also, while the ESM has just been approved by Germany’s parliament, it must also be signed by German President Joachim Gauck. The problem here is that Gauck has agreed to withhold approval pending the outcome of several lawsuits seeking to challenge the new laws as unconstitutional.
Another big issue it that the ESM’s lending capacity of €500 billion simply isn’t big enough. As the FT points out, “It will inject equity into Spanish banks. It will need to refinance the programme for Greece, Ireland, and Portugal. It will soon have to cope with Cyprus and, who knows, maybe Slovenia as well.”
The bailout plan is likely to do little to boost economic growth or employment prospects. Essentially the plan amounts to more of the same, i.e. creating additional debt to resolve the problem of too much existing debt. Interestingly even Angela Merkel softened her hard line on fiscal discipline and debt repayment, signalling that she is now willing to accept loser monetary policy.
From a political point of view the agreement establishes a much clearer path towards a United States of Europe which is arguably the only way to save single currency.
On receiving the news of the bailout, markets immediately went into “risk off” mode as traders and investors bid up the price of risk assets such as stocks and commodities. The Dow closed up more than 2% at 12,880, while crude oil closed up 8% at $84.82 a barrel. Gold too reacted to the prospect of more stimuli rising almost 3% to $1,597 an ounce.
The move into risk assets was accompanied by a move out of the perceived safety of government bonds and the US dollar, with the US dollar index falling 1.4%.
The bottom line
For investors waiting to jump aboard the next QE-fuelled bull market this latest rescue plan is likely to be something of a disappointment. As Wolfgang Münchau writes in the FT, “One of the lessons from the history of financial crises is that bazookas must be big to be effective. This one is not.”