The euphoria driving the market higher over the past few weeks is best illustrated by the 150 point spike in the Dow which occurred in about 5 minutes during the last hour of today’s trading day. The markets soared on the back of The Guardian’s report that Germany and France agreed to agree on expanding the size of the EFSF to 2 trillion Euros from 400 billion Euros.
It seems that the strategy of European officials has been to shock markets by releasing tactical statements, sort of like good cop bad cop. For example, German Chancellor Angela Merkel made comments yesterday and today aimed at managing expectations of a silver bullet solution to the European debt crisis. Then, out of nowhere comes the EFSF expansion announcement resulting in the market spike. But these officials should realise that this tactic is a feeble attempt at dealing with the symptoms and not the actual problem. Market direction is not a barometer of economic health. Borrowing money to pay down debt does not seem like a sustainable solution to the European DEBT crisis. A statement saying that they will just borrow 5x more than planned will probably make things worst not better. Considering that France’s AAA rating is under review, I find the plan to be an astute example of flawed European logic as increasing the debt load on a fragile sovereign credit system will only amplify Europe’s problems in the long run.
Expanding the EFSF to 2 trillion Euros screams that not only is the problem much worse than people previously thought, it is probably much worse than even the expanded EFSF can handle. The truth is nobody has any idea of what is happening with the ECB, IMF, Troika, PIIGS, Germany and France. All we have are the headlines and rumours to go off of. Frankly, I am certain the men and women in charge over there don’t even know what is happening and hence the volatility in the equities and fixed income markets. Reading through the reported optional plan to prohibit naked CDS buying one can understand how dire things have become in Europe. Their last ditch effort is to simply attack buzz words not realising that banning CDS will most likely lead to higher borrowing costs for European nations. Plus, the CDS markets are hardly the cause of rising borrowing costs for debt laden countries whose main global contributions are feta cheese and olive oil (there is also shipping and tourism but whatever).
The swings in CDS prices (across the board) over the past few months has been nothing less of dizzying, simply because a tremendous amount of uncertainty remains. But fundamentally, nothing has changed and the European crisis is bound to implode at worse and at best will not meet the expectations set by the ECB. Potentially we have this “Q4 Rally” that everyone has been comparing to Fall 1998 but really who cares? At any given moment a simple headline could take the floor out and it is not worth the risk for most investors.