@Aurelija's

A joyful week for the markets - the meeting of the European leaders led to immediate euphoria across the board, with equity markets gaining up to 4% in a day. This paper from the meeting was something that the markets had long waited - and it did not disappoint. Merkel and Sarkozi hadn't lied when they several weeks ago promised a "comprehensive" plan for solving the euro area problems. This is it - 50% writedown in Greek debt, bank recapitalization to 9%, increasing the European bailout fund to EUR 1.4 trillion up from just over EUR 400bn now. Sounds big, on the surface.

While the markets did take it with optimism, it is not yet certain whether this is the silver bullet yet. After all, thinking about each solution from the plan in isolation, it turns out that many details are still missing.

For example, the 50% writedown in the Greek debt - is that enough to make the Greek debt "sustainable"? Apparently not. Even with this seemingly drastic haircut the Greek debt to GDP ratio will exceed 150% for years, only to stabilize at ...still above 120% by 2020. This hardly sounds sustainable. Secondly, the writedown itself poses lots of question marks. For example, the fact that it will be "voluntary" - how will this work in practice? And, will this event be treated as a "default", triggering the CDS market? If not, does it mean that the CDS market is dead - that is, people buying Greek debt and CDS on top are not protected from the haircut?

As regards the recapitalization of Western European banks - ok, they are given now 9 months to shore up their Tier 1 capital ratios to 9%. For that they need to go out and sell some equity. Will there be many willing buyers? Somehow I doubt it. If the banks do not succeed raising the capital ratios via equity issuance, then what is left basically is reduction of the balance sheet, which will end up in reduced lending, maybe even sell-off of some assets in the Central and Eastern Europe. Hardly this is something that will positively affect the already troubled European economy in the coming year.

And turning to the European Financial Stability Fund (EFSF). It sounds nice they increase it multiple times. But then - how they are going to achieve it? One part will come from guarantees of the Western countries. But does it really smell good - remember, France is already threatened to lose its AAA rating by rating agencies. This will ultimately reduce the rating of the fund. So much of the "guarantee" - it hardly helps when the guarantors cannot live up to their pledges. The second part of the bailout fund will come from establishment of the special purpose vehicles where the European leaders expect China, Brazil, Russia and other large sovereigns to contribute. Without them having promised anything for today the expansion of the EFSF is just words and promises.

One more big problem with the plan of the European leaders is that it poses some moral hazard risks. Now that Greece is being helped, other countries may require "pari passu" conditions. In the markets this may mean spillover effects to other countries. Unfortunately, that negative sentiment was already observed yesterday when after poor results of the Italian bond auction the yields topped 6%...


If this becomes a trend, then we are back to where we started from.

Last but not the least, the sentiment in Europe is worsening, with the Germans being unhappy to finance the European periphery, and the periphery hating the Germans for imposing the tightening of the belts. The latter may be seen from how the Greeks portray the German Chancellor in street posters these days...


Growing adversity risks splitting the euro zone at some point anyway.


We will see how things will develop in the euro area. Meanwhile the eyes will also turn to the US economy, which will as well affect the risk sentiment in the coming weeks. The economic surprises have been positive for the US in the recent few weeks. Among the recent ones - the GDP came out slightly better than in previous quarters. An interesting development - the US consumers are reducing their savings rates...


...which hopefully is a good thing, showing the US consumers are getting more comfortable shopping. But reduction in the savings rate may also be worrisome if wages do not keep increasing. With the unemployment stubbornly high the wage pressure is low. So, the only hope now is the US labour market keeps improving - this we will find out after the next Friday's non-farm payrolls report. If positive, it may help further support the risk appetite in the global markets - something that the stressed European sovereign bond market is in crucial need for now.