LAST weekend’s unprecedented move by the EU and IMF to create a rescue package worth nearly $1 trillion to guarantee sovereign debt within the Eurozone was a gargantuan policy effort to stabilise the euro. The deal created an array of measures, including $560bn in new loans, $76bn under an existing facility as well as additional credit from the IMF of up to $321bn. To further buttress the moves of the fiscal authorities, officials from the Fed, the European Central Bank, the Bank of England, the Bank of Canada and the Swiss National Bank all agreed to reopen currency swap lines in order to ease liquidity in the money markets and the interbank markets.
The concerted effort by the EU finance ministers and G7 monetary authorities was a clear sign to the markets that they stood ready to rebuff any speculative runs at the credit instruments of southern European economies that have threatened the financial stability of the Eurozone and the prospects of the euro itself.
For the time being, the plan appears to have worked. Credit default swap spreads have narrowed considerably and the weekend action put aside all speculation about possible fragmentation of EU. The euro soared in the aftermath of the news as late shorts scrambled for cover. The short euro trade has become incredibly crowded and Monday’s price action likely squeezed the latecomers out of their trades.
However, long-term questions about the viability of the deal remain unanswered. The EU arrangement calls for the creation of a special purpose vehicle with a duration of three years that will be dependent on “national constitutional arrangements” in order to be put into effect. Several key Eurozone members are facing massive rollover risks over the next two years with Italy having €600bn of debt that is due while Spain will have to refinance €220bn and Portugal will need to raise more than €40bn over the same time frame. As of now, it is not at all clear if such a structure will be robust enough to withstand the possible financial stress that may still come.
Boris Schlossberg and Kathy Lien are directors of currency research at GFT. Read commentary at www.GFTUK.com/commentary or e-mail firstname.lastname@example.org.