Markets wait for the devil in the details

“THE EURO continues to rest on solid fundamentals,” proclaimed the Eurozone statement put out at 4am yesterday morning.

Despite surpassing markets’ low expectations and providing some patches of long-desired detail, the statement was met with increasing scepticism by the evening.

Leaders agreed to leverage the European Financial Stability Facility (EFSF) – the region’s bailout fund – by “up to four or five” times, for example, after Chancellor Angela Merkel won parliamentary permission for Germany to take on most of the risk.

But with only €280bn of the €440bn fund available for leveraging (the rest being already committed for bailouts), that puts its firepower around €1 trillion – half market hopes of €2 trillion.

More pressing is how it will be achieved. The details of how Europe plans to create a collateralised debt obligation to share risk between junk bond-issuers (Greece) and triple-A issuers (Germany) will be key to judging its viability. They are promised in November.

Another question is who will buy the debt amassed by the EFSF. Euro leaders are keen to tap the billions in reserves built up by China and Middle Eastern states. But the world’s wealthiest sovereigns will not buy any old junk – they will have to be sure that enough German money stands behind it.

Even if Europe can pull off this clever financial engineering, however, its success comes back to the “fundamentals” of the euro.

Markets simply don’t believe they are “solid”. Mediterranean economies, most notably Italy, are charged with unwinding a decade of economic mismanagement, tearing up their welfare states, labour rules and pensions.

On Monday, French President Nicolas Sarkozy was asked whether he has faith in Italy’s leaders to take on the challenge.

His reply? A smirk.