Europe’s Wider Firebreak: €750 Billion Euro Liquidity Fund

The Euro countries have finally grasped the magnitude of the financial contagion and have acted decisively to create a wider firebreak in the form of a €750 billion liquidity fund. In a joint emergency session over the weekend, the Euro countries along with the IMF created the fund to provide loans and loan guarantees (€440 billion in guarantees and €60 billion in direct funding with the IMF providing an additional €250 billion). The ECB has reintroduced unlimited fixed-rate liquidity injections (the ECB plans to conduct a six-month operation in May) and the Fed has reactivated the currency swap lines with the ECB (which will enable the ECB to provide dollar liquidity to European banks; 3-month dollar LIBOR fell 3 basis points to 42bps today). In addition, the central banks of Germany, France, and Italy said they were buying government bonds (an unspecified amount and currency composition at this point). So much for Trichet’s bravado last Thursday when he said that the subject of buying bonds was not discussed at the ECB’s regular policy meeting.

As we warned last Thursday, the U.S. markets were overreacting to the contagion risk and that Europe would do whatever it took to stem the contagion. The reaction in the markets has been massive. Yields on Greek two-year government bonds have plunged from 18.2% on Friday to 7.8% this morning. Yields on 10-year German bunds have moved up 17 basis points, to 2.96%. Stocks have responded very positively in Europe with the French CAC 40 index up 8.7% and Germany’s DAX up 4.8%. The responses in the U.S. market have been similar as 10-year Treasury yields have soared 17 basis points, to 3.60% and S&P futures are up 52 points. Gold has pulled back $18/oz to $1194 per ounce (although these stabilization moves do not alter the longer-term attractiveness of hard money, in our opinion) and the Euro has rallied to 1.296$/€ from 1.276$/€.

For the U.S. markets, investors should remain focused on U.S. fundamentals and Friday’s jobs report showed surprisingly solid private job growth over the last two months, which has been the missing link in the recovery to date. After the March employment report, U.S. 10-year yields hit a high of 3.99%, which is 41 basis points higher than current levels. For Europe, these massive actions should deal with the contagion of Greece’s problems to the rest of the PIGS—the speculators have been massively burned—however it is vital that this is followed up over the medium term with strong actions to cut government budgets and reduce deficits. This latter point is something that long-horizon investors in the U.S. bond market should reflect on since there is no plan to deal with U.S. fiscal problems at this point.
Footnote on the U.K. Elections
The Lib Dems have been negotiating with both the Tories (a Conservative Lib Dem pact is the only majority that can be formed) and Labor over the weekend. For now, Gordon Brown remains prime minister and the impasse continues. U.K. 10-year gilt yields are 10 basis points higher this morning, at 3.93% (although the FTSE has rallied 5.4%).

Source RDQ


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