There were numerous issues to worry about, including the CDU’s decision to scupper Angela Merkel’s idea that the EFSF and ESM could run in parallel, the German proposal to appoint an EU budget commissioner to veto tax and spending decisions in Greece and fresh concerns over the rapidly deteriorating state of affairs on the Iberian Peninsula. Video:

Given the extensive provisions on monitoring, sanctions and (hopefully) a path towards fiscal union, it was fanciful to think that the non-euro EU members should be included in such a treaty, unless it contained numerous exclusions and provisos. Video:

The Aussie took a dive following this move, but it found support and bounced back up. Update.

From one angle, given that we are in a sovereign and developed market crisis, the same should happen this time around, not least because the IMF sees developed market sovereign debt rising over the next five years (up to 106% of GDP) and developing market debt falling (to 29%).  On the wider picture, these themes are likely to dominate, but nearer term the slowing in China has to be managed.  It requires a more sustainable pace and better balanced mix of growth in the near-term, but without getting caught in the downdraft of the developed market slowdown.  It’s a fine balance to achieve.

The distance between the ‘haves’ and ‘have-nots’ is growing ever greater. German yields are down nearly 0.25% so far this week and in Switzerland, investors are paying the government to have their money, yesterday’s 3-mth t-bill sale coming in at a yield of -0.30%.  Even at the very short end of the German curve, some t-bills are seeing negative yields, but not yet on a consistent basis. For currencies, the bond sell-off led to more risk aversion.

For sure, the Berlusconi administration was often steering the wrong course, with the captain in the cabin rather than on the bridge, but the numbers remain the same.  Italian yields are pushing 7% on the 10yr bond, growth has been anaemic for years (averaging 0.7% since start of EMU) and debt remains 120% of GDP.  Furthermore, the lifeboat (the EFSF) is insufficient to perform a successful rescue. We remain in very testing times, but the euro itself also remains relatively resilient.  The impact on Italian bonds is being overshadowed by the increase in margins from one of the main clearers, which makes it even more costly to hold Italian debt.

But this puts the troika in a difficult position.  Having just agreed the latest EUR 5.8bn loan instalment, it is now faced with the position of lending further money to a country that could potentially renege on the conditions of all the outstanding lending.  Greece has EUR 8.2bn of maturing debt in December and EUR 15.1bn in Q1 next year. It would be totally irresponsible for the EU and IMF to disburse any more money to Greece whilst the potential for a rejection of the new EU/IMF deal is possible.

Greek debt-holders have apparently accepted a 50% haircut, and European banks are to be recapitalised. Also announced was a more significant role for the IMF (although exactly what that role will be is not yet clear), and the continued involvement of the ECB with respect to buying the bonds of troubled European sovereigns in the secondary market.

And yet despite all of this seemingly bad news the AUD has lost only 2.5% against the dollar this month, and is down less than 3% against the euro.

We’ve talked before about the curse of the dollar’s reserve status, limiting the market impact of the ever more likely downgrade. Two factors are more prevalent now. Firstly, the economic impact of a government running on 50% spending capacity which, if sustained, would likely push the US back into recession.  Secondly, there’s the impact of trade unwinds where the dollar/Treasuries is the short-leg.  This will put a temporary downward force on bond yields. Add to this the fact that many investors in treasuries have little alternative for regulatory or liquidity reasons, then the rush for the exits that many have feared may never materialise.