The Two Drivers

There are two main concerns which appear to be driving the price action.  First, there is heightened anxiety about the global economic slowdown.  This is evident in the fact that easing of monetary policy by four countries (China, the UK, the ECB and Denmark) failed to breathe fresh life into the moribund animal spirits.  

Second, is that the European debt crisis continues, though the deck chairs of what many increasingly believe is a Titanic of sorts have been moved around a bit.  

As BBK President Weidmann’s comments yesterday attest, there is much room in last week’s agreement for interpretation, in both the legal aspects and implementation.  Merkel can honestly tell the German parliament, as she has done, that she did not “blink” or cede any substantive point, including conditionality.  Rajoy,  Monti and Hollande can honestly claim an important victory, as they have intimated.

The euro zone finance ministers will meet Monday and this will be the beginning of the formal process of negotiating precisely what was agreed upon by the heads of state last week.   There has been an informal tete-a-tete throughout the week.  

In this fairly murky political situation, a few  things are clear.  

First, the ESM will not get a banking license in the foreseeable future.  This puts a clear limit on funds available.   Such known limits are thought to undermine the credibility of such funds.

Second, the real debate is not whether or not there will be conditions attached to bank recapitalization by the EFSF/ESM, but whether the conditions are light or heavy.  Will they apply to the bank or the sovereign?  

Third, Germany is not as isolated within the euro zone as some observers suggest.  Although we have made this point before, it is increasingly important to recognize that other creditor nations are taking an even stronger stance than Germany and this injects a new complication in the effort to increase cooperation and integration. 

Fourth, our view that the SMP and LTRO policy tools are off the table was only strengthened by Draghi at the ECB's press conference.  Not only was the cutting of interest rates, which means cutting to the refi rate to a new record low (and lowering the interest rate on the LTROs) and bringing the deposit rate to zero unanimous but apparently SMP and LTRO were not even discussed.