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The drama surrounding the euro crisis has been reported in spectacular fashion in the media. Past EU summits have been characterized as “the last chance to save the euro.” The most recent EU meeting in Brussels was no exception even though financial markets had lowered expectations of a big result. Even though I dont think such sayings as “the last chance to save the euro” make much sense, the outcome of this summit can be considered as progress.
Making Sense of the Latest EU Summit
First of all, European countries showed a deeper commitment to European integration (“more Europe”) by addressing some of the key issues of the euro crisis. (I recently highlighthed this topic in my letter “A Tale of Two Cities” ). The leaders officially acknowledged, with the appropriate sense of urgency, the need to break the cycle between governement debt and the Financial sector, that has made this crisis so difficult to resolve.
The Main Achievements
This meeting has laid the foundation for European banking supervision (one element of a banking union) and a greater flexibility in the use of european funds to stabilize financial markets, even though a roadmap for fiscal integration is still missing.
All countries had to make some compromises. Germany accepted the more active role of the ESM (European Stability Mechanism) in a direct Banking-sector recapitalization and the active intervention of the ESFS/ESM to stabilize sovereign bond markets. However, the “lighter” conditions have yet to be defined. (The latter was strongly recommended by the Italian Prime Minister).
A controversial aspect of the Spanish banking bailout has also been clarified, in the sense that the EFSF will lead the bailout until the ESM becomes effective, but it should not have a preferred creditor status over private bond-holders. The point that still needs to be clarified is whether this will apply only to Spain or if it will also be extend to all countries.
In addition, the European Commision will shortly present a proposal for a European banking supervision authority, to be urgently approved by the end of the year and with the ECB taking the lead.
A Game Changer?
In my opinion, as we didnt see reasons to be overly pessimistic, we should avoid being overly optimistic. However, I definitely believe the glass is half full. I dont think that this would be the ultimate game changer. More analyses are required and several details are missing. I see it as a long journey to a stronger European Union. In the meantime, we expect that volatility could remain high.
The Possible Impact on Risky Assets
The expectations for the EU summit were so low that a period of relief is possible in the short term, but, as I said earlier, volatility will probably remain high. From a more strategic perspective, I believe that some assets provide good value to investors, such as peripheral government bonds or European equities, which also offer attractive dividend yields. We think that the so-called ‘safe assests’, such as core government bonds, are overpriced and are pricing in a too pessimistic scenario for the eurozone and for the global economy overall. Credit markets, in the broader sense, and Emerging Markets, both equity and fixed income, continue to be a strategic choice for us in the search for yield.