Anticipating the Irish Relief Rally

More on Ireland Here

Officials from the EU, IMF and ECB are in Dublin today to assess the magnitude of the aid needed and to negotiate the terms. Ireland does have a trump card, though may lack the political will to use it. It was among the first countries to guarantee bank debt. It could find German Chancellor Merkel is right.

Merkel is right in that burden sharing is necessary. If the EU/IMF/ECB wants the fragile Irish government to renege on promises about no more cuts in government workers'pay, that those same forces, might compel Ireland to re-think its guarantees on bank debt. Isn't it because of the ramifications of such a move, a wider questioning of all guarantees, and through the euro zone into greater disarray, and hitting the weakened banking systems again?

Germany and other European countries also appear to have their sights set on their long-time nemesis, the low Irish corporate tax rate (12.5%), In the tax competition that takes place within the euro zone, which caps other countries ability to raise corporate taxes. Irish officials argue that it is sanctioned in the Lisbon Treaty, despite the complaints.

It is not clear when the details will emerge but there are two aspects to watch for: One, since it is about Irish banks, less the sovereign, will Ireland be required to increase the 6 bln euro fiscal adjustment projected for next year and the 15 bln savings it projects in the four year plan now expected toward the middle of next week (but the situation of course is very fluid)? Two, can Ireland keep the aid to some kind of contingent funding rather than direct financial assistance.

Unlike the episode earlier this year, which was resolved largely through liquidity measures, the solvency dimensions are more on the forefront now. We are suspicious about how long an an aid package for Ireland, whatever the contours of the package, will keep the proverbial wolf away from the door.

The greater risk seem to lie with renewed pressure in in the periphery after a short respite. This also fits in with two factors we continue to monitor for insight into the euro-dollar direction. The 2-year interest rate differentials between the US and German have stopped moving in the US favor and the premium the market pays for euro puts over euro calls has stopped widening.

These are not the end-all or be-all, but offer helpful insight and that insight and the beginning of buy the rumor of a Irish package (with an eye toward selling on the fact ?) has lifted the euro 2 cents since Tuesday. Technical corrective pressure could see the euro recover toward $1.3770 at least initially. This could see sterling toward $1.6100 and the Australian dollar back toward parity. Dollar-yen marches to its own tune, but the yen is likely to under-perform on the crosses.