Anyone who has followed the nearly three-year-old debt crisis is familiar with the pattern: The euro—and financial markets—rally in anticipation of decisive action. Gains extend maybe a session or two past the end of the summit, then it all comes apart.
This time around, however, the euro’s rally may have little to do with misplaced expectations the summit will produce any major breakthroughs on investors’ current preoccupations — a full bailout for Spain and the disbursement of the next round of desperately-needed aid for Greece.
That’s because European leaders finally appear to be getting the hang of managing expectations down.
“The market is well prepared for a meeting with no new measures,” said Anders Moller Lumholtz, senior analyst at Danske Bank in Copenhagen, in a note to clients.
Instead, strategists say the focus remains on the leader of Spain, Prime Minister Mariano Rajoy, and expectations he’ll soon bite the bullet and request a long-expected sovereign bailout. In turn, that would potentially allow the European Central Bank to implement its high-powered bond-buying program, known as outright monetary transactions, or OMTs.
The summit gets under way at 5 p.m. local time, or 10 a.m. Eastern, in Brussels on Thursday, as European leaders meet for dinner. Further meetings take place Friday.
The euro EURUSD -0.26% EURUSD -0.26% traded at $1.3090 on Thursday, down from $1.3121 in North American trade late Wednesday, but remains up more than 1% for the week-to-date and 1.8% since the start of the month.
The shared currency jumped as high as $1.3139 Wednesday, its highest level since Sept. 17.
Wednesday’s gains came after Moody’s Investors Service late Tuesday completed its long-awaited review of Spain’s credit rating. Euro bulls cheered as Moody’s opted not to cut Spain to junk status, although the firm placed the rating on negative outlook.
Spain’s 10-year bond yield ES:10YR_ESP +0.92% on Wednesday fell to a six-month low around 5.46%. The cost of insuring Spanish government debt against default using instruments known as credit default swaps dropped Wednesday to its lowest level since July 2011, according to data provider Markit.
The euro also rallied Tuesday on news reports Madrid was edging closer to requesting a precautionary credit line from the European Stability Mechanism.
Simon Smith, chief economist at FxPro in London, questioned the logic behind the euro’s gains.
“So, the euro was higher because Spain thinks that the mere presence of a credit line will be enough to restore market confidence and push borrowing costs down further. This seems to be like getting an overdraft facility with a new bank and expecting to get better terms with your current bank,” Smith said in a research note.
Under the ESM’s rules, such a credit line can, in theory, last only a year, he noted, while the International Monetary Fund and European Union will presumably demand austerity measures that will continue to bear down on the country’s already ailing economy. “It looks a stretch to think this arrangement will allow Spain to turn a corner,” Smith wrote. “The euro will realize [that] at some point, but not right now it seems.”
Greek officials this week were quoted as saying that talks with the country’s troika of bailout lenders — the European Union, International Monetary Fund and ECB — were unlikely to be completed in time for the summit.
At the same time, the euro has been buoyed by indications German Chancellor Angela Merkel is more open to giving Athens more time to meet its deficit targets.
Still, signs of friction between Greece and other euro-zone countries over austerity measures could serve to help limit euro gains, said Jeremy Stretch, currency strategist at CIBC, in a note.
Among other issues, talks on proposals for a European banking union will be on the table. But with Germany and France at loggerheads over the timing, there’s a strong chance the plan will be postponed, said Danske Bank’s Lumholtz.
In the end, maintaining tactical long positions in the euro still appears to make sense, Stretch said, at least until Spain asks for assistance.
“When that occurs, the key question will be how long will it be prior to the realization that any bond purchases” won’t alleviate Spain’s fundamental economic problems,” he said.
Marketwatch
