Oil and stock prices soared Oct. 27 in what one analyst described as “a monster market bounce” after Euro-zone members agreed to reduce Greece's sovereign debt, support European banks facing additional losses on Greek bonds, and increase the European Financial Stability Facility (EFSF) to €1 trillion.
The front-month crude futures contract shot up 3% on the New York Mercantile Exchange when the deal was announced. But prices retreated slightly during the next two trading sessions due to lack of details in the agreement and a growing fear that something yet could go wrong. Those fears were realized Nov. 1 when the Greek government unexpectedly called for a referendum on its austerity program, which is likely to wreck the agreement. The news shook the markets.
Even among the initial euphoria, Olivier Jakob at Petromatrix in Zug, Switzerland, warned, “One of the key problems with the latest European rescue plan is that it is not a ‘European Union deal’ but a ‘Chinese deal.’ It will come at a great political cost. We are not sure that it will do much for European consumer confidence and is for us a sign of total failure of Europe. Athens has its fate in the hands of Brussels [EU headquarters], and now Brussels has its fate in the hands of Beijing.”
Despite talk of non-European countries like China riding to the rescue, Chinese and European officials played down expectations for near-term investment by China in the Euro-zone. China’s vice-finance minister said his country wouldn’t act until late November or December when details of the EU agreement are assessed.
Other problems
Benn Steil, director of international economics at the Council of Foreign Relations, said on the day of the agreement: “This [was] the 14th Euro-zone leader summit in the last 21 months, and there are going to be many, many more over the next 21 months. So this is not the end game by any stretch of the imagination.”
Sebastian Mallaby, director of the CFR Greenberg Center for Geoeconomic Studies, said European banks might not write down Greek debt without putting additional conditions “into the fine print—which actually happened after the July deal—that will mean that the real write-down is quite a lot less than 50%.”
Euro-zone members are talking about European banks raising €106 billion in extra equity capital by June. “But of course, they haven't provided any details about how the banks are supposed to raise such capital. It'll be exceptionally difficult for them to raise such capital cost-effectively in the foreseeable future.” Steil said.
If Euro-zone members impose such a write-down on Greek bonds, “wouldn't they do it for Portuguese bonds too?” Mallaby wondered. “I think banks are going to be worried about that.”
Moreover, EU leaders’ stated intent to leverage the EFSF “to get more fire power” is “effectively admitting…the bailout fund they have is too small to be effective.” Mallaby said, “They're not saying how this leverage is going to work or what the unintended consequences might be, so how can a stretched government [such as] France, which is already facing the danger of a credit rating downgrade…leverage its commitment to the fund without further imperiling its credit rating?”
If EU members guarantee some of the new bonds being issued, there would be “negative consequences” for “the other bonds, the outstanding stock, which will not be insured, and that, again, will hurt the banks who own all this dead stock,” Mallaby said, because the insurance likely will apply only to the new bonds that get issued.
“Euro-zone inflation is so high that in theory it does not call for the European Central Bank to announce a rate cut in the near future,” said Jakob. But he doesn’t exclude the possibility of a rate cut “in an environment where rules are happily broken.”
(Online Nov. 1, 2011; author’s e-mail: [email protected])
