The EU rode to Ireland’s rescue the other day, as expected, putting together an €85 billion ($113 billion) bailout package. The move, however, did little to dispel the belief that other countries, such as Portugal and Spain, will eventually need assistance before long as well. The euro continued to slide, bond yields have risen further, sovereign credit default swaps (which are insurance against bankruptcy) have climbed to record levels and stocks remain under pressure.
The reason for binary options investor pessimism over there is straightforward: The bailout plan does nothing to address the fundamental issue confronting the EU’s monetary union. Absent a default and with no mechanism to devalue their own currencies, the weaker euro participants are going to need continued support from their healthier, wealthier EU counterparts to hold them over until they can grow their way out of trouble.
In addition to thumping their chests and declaring the euro saved by their sending Dublin a lifeline (a boast that rings all too hollow), officials from Germany and France sketched out the makings of a long-term European Stability Mechanism (ESM) that will create a permanent bailout facility for the elliott wave euro zone. One aspect of the ESM that is long overdue is that it will gradually make the private sector shoulder a portion of the burden of any future default.
This morning Bloomberg is reporting that Spanish banks will need to refinance roughly €85 billion in debt in 2011. With bond yields rising, the cost of refinancing that debt is getting dearer. And while the Spanish financial system isn’t as fragile as Ireland’s, it too is weighed down with debt. Should it come to Spain requiring aid from the ESM, the continued existence of the euro monetary union will be in jeopardy. In the meantime, deep spending cuts by debt-heavy governments across the continent are going to inflict a good deal of pain. Ireland’s economy, for instance, is expected to contract by about 10 percent next year as a result of the austerity measures the Cowan government is proposing.
Slower growth in Europe is likely to take its toll on US exports, at a time when our economy is still struggling to expand. On the plus side, our economy is showing renewed signs of traction, which should help to offset lost sales to Europe.
The market is also encouraged by the belt tightening President Obama announced yesterday in the form of a freeze on government salaries (excluding the military). The move is expected to save $2 billion through the remainder of this fiscal year and $28 billion in the next five years.
On the geopolitical front, a US naval carrier group is now conducting exercises off the coast of South Korea. China has called for renewed dialog between the two sides and their allies, although South Korea is hesitant to join any talks given the North’s recent actions. Tensions on the Korean Peninsula remain high, but the markets are not acting likely the conflict will escalate.
Today’s S&P/Case-Shiller home price data isn’t helping matters, but the US stock market has absorbed a great deal of bad news lately. Also encouraging, equities have the benefit of the seasonal tendency for share prices to rise toward the end of the year and into the New Year, although positive returns are by no means guaranteed. So while we are cautiously optimistic here, we don’t have a strong conviction on the near-term direction stocks will take and therefore we aren’t in a rush to take on new positions.
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