Focus was again on Europe, with high expectations that a late-week summit of European leaders could produce credible plans to halt the spiral of rising yields on sovereign debt. Indeed, in the wee hours of Friday morning, a preliminary agreement was released. It contained several key points. First, it should speed the creation of a 500 billion euro rescue fund to backstop the EFSF. Second, it diluted the severity of losses private bond holders would suffer in case of default. Third, it set a March deadline to agree on language for the new rulebook of increased fiscal responsibility. Importantly, Britain abstained from the agreement, meaning it will ultimately be solidified in the form of inter-governmental agreements and not a new EU treaty. Several other non-Euro EU members must also get domestic approval before officially endorsing the new measures. The outcome disappointed some, who hoped for explicit mention of an expanded ECB role in backing distressed nations. Still, stock markets cheered the progress, rising on the news and finishing up for the week.
- S&P 500: 1,255 (+0.9%)
- MSCI EAFE: +0.4%
- US 10 Year Treasury Yield: 2.06% (+.01%)
- Gold: $1,711 (-1.7%)
- EUR/USD: 1.3375 (-0.3%)
- Monday – The ISM non-manufacturing index unexpectedly fell to 52.
- Monday – Standard and Poor’s said they will be placing Europe’s six AAA rated members on negative outlook, opening the door for possible downgrades in the future.
- Thursday – Stocks fell as the ECB dampened speculation that it would increase bond purchases.
- Thursday – The European banking authority said EU banks must raise 114 billion Euros in fresh capital, up from a previous estimate.
- Friday – Eurozone members agreed to a new treaty that would enforce a fiscal compact promoting fiscal responsibility. The treaty would also expand the European Financial Stability Fund and remove the requirement that private investors take a hit in future rescues. Britain did not join the agreement.
- Friday – US consumer confidence hit a six month high, according to the University of Michigan survey.
Perhaps it should be concerning that important decisions in Europe often seem to be completed in the middle of the night, but Friday’s announcement is positive. Most importantly, Merkel finally seems to have given her blessing. This probably means Germany has obtained the concessions it wanted in order to look the other way as the ECB ratchets up its bond buying. Equity markets should like this, but it is important to realize the deal is not solidified. Several EU (but non-Euro) members still need it ratified at home, and Britain chose not to be included, meaning the deal is actually not a new EU treaty. There will be future objections and hurdles. But, overall, we believe Europe is taking the necessary steps to stay intact and eventually recover. Even so, much of Europe will likely suffer recession first—a reality we believe is already reflected in markets.
In related news, the rating agencies continue to prove their worthlessness. Just a few years after blessing billions of dollars of sub-prime mortgages with AAA ratings, Standard and Poor’s has stripped the US government of its rating and is now threatening to do the same to Germany and France. If these entities are not AAA, who is? What is the point of having AAA ratings if no one has it? AA simply becomes the new AAA. Regardless, markets barely reacted to their threat of downgrades in Europe, meaning the rating agencies have officially squandered most of their ability to artificially impact markets. This is a good thing.