5 Holes in the EU Summit Agreement – EUR/USD Rally

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This late night European Union Summit had some achievements. France, Italy and Spain insisted on focusing on measures for the current crisis, and not only long terms visions. The leaders agreed on allowing the bailout mechanism to directly recapitalize banks – a move that allows lifts the burden off Spain. In addition, the ESM will have no seniority, thus expected not to scare off private investors.

Spanish yields are falling and EUR/USD reached high resistance before retreating. Will this rally last? Or is this another short-covering rally like the post Greek election rally and the post Spanish bailout rally? Let’s see the decisions:

  1. Bank Recapitalization by ESM – it could happen: The word “could” is important to note. This is not decisive enough. There are additional conditional words in the statement.
  2. Dependency on a supervising mechanism: Direct bank recapitalization depends on establishing a body that will supervise over the banks. Germany insisted on this. While it makes sense, this slows down implementation and is contradiction to the urgency also expressed in the statement.
  3. ESM not ratified: It’s important to note that these changes to the ESM require ratification by the 17 member states. Not all of them have approved it. One country that hasn’t approved it is Germany – the supreme court delayed the ratification.
  4. Directly paying banks is harder to sell: Solidarity with struggling countries has some political support, but taking taxpayers’ money and directly funding foreign banks? This might be a good solution for the markets but the public in many countries will not like it.
  5. Bailout mechanisms fall short: Spain is the euro-zone’s fourth largest economy. When it draws its contribution out, the burden on other countries will be larger. If Italy needs help (this is certainly feasible), the burden will be even larger.

The big achievement is removing the seniority from the ESM – this means that private bondholders will not be afraid to invest in these bonds. The official sector had seniority in the Greek debt restructuring. In fact, the ECB made a big profit on Greek bonds while the private sector had an effective haircut of around 75%.

Yet again, it seems like the leaders had a hard time making a real breakthrough and that they scrambled to reach an agreement that would satisfy markets. We’ve seen that before with the Spanish bailout announcement – an announcement full of holes that had a sole and unsuccessful intention to stabilize markets.

EUR/USD rallied to the 1.2624 line  which was January’s low and a critical resistance line. It then slid back and is now trading at 1.2560. This can still be viewed as a healthy correction: the pair rallied all the way from the 1.2440 line.

However, this may not last. The market may see the holes soon enough.

See more about the euro in the EUR/USD forecast.

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About Author

Yohay Elam – Founder, Writer and Editor I have been into forex trading for over 5 years, and I share the experience that I have and the knowledge that I’ve accumulated. After taking a short course about forex. Like many forex traders, I’ve earned the significant share of my knowledge the hard way. Macroeconomics, the impact of news on the ever-moving currency markets and trading psychology have always fascinated me. Before founding Forex Crunch, I’ve worked as a programmer in various hi-tech companies. I have a B. Sc. in Computer Science from Ben Gurion University. Given this background, forex software has a relatively bigger share in the posts.

37 Comments

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  4. Alex, it seems you were caught by the rally!
    Don’y worry it happens to everyone.

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