France And Italy Propose Using Bailout Funds To Buy Sovereign Debts

France And Italy Propose Using Bailout Funds To Buy Sovereign Debts

Good morning and welcome to today’s foreign exchange market commentary on Thursday, the 21th of June.

France and Italy have proposed using the bailout funds the EFSF and the ESM, to buy sovereign debts to restore investor confidence. Mario Monti of Italy and Francois Hollande want the rescue funds to buy sovereigns. Creditors are however, more likely to offload their holdings of peripheral bonds.

The idea is not new. Theoretically the funds can buy bonds from the secondary markets. Countries requesting the intervention have to accept some form of conditions. Mario Monti’s proposals are somewhat radical; he wants an automatic intervention whenever bond yields breach a certain level. This way investor fear of losing money can be addressed and Spanish and Italian governments would be able to tap the capital markets.

The flaw in the proposal is that the funds have limited lending capacity. The combined capacity of the EFSF and the ESM are €500 billion, including the €100 billion committed to Spain already for bank recapitalizations. If the lending power can’t be used effectively, investor worries over sustainability will remain and they will dump their holding at their earliest to exit. And Italy won’t benefit once the rescue funds are swamped.

It is imperative to say that Europe will quickly move to plan B if bond-buying doesn’t work; a full-blown bailout for Spain and Italy and restructuring debts held by private creditors will be the next step. We have already seen it in the Greek debt swap and any hint of it will send investors running for the hills. The European leaders must go far ahead than their current idea of buying bonds from the secondary markets if it wants to convince investors that the euro is not truly heading for a break up.


GBP/EURO – 1.2364
GBP/US$ – 1.5678
GBP/CHF – 1.4863
GBP/CAN$ – 1.6026
GBP/AUS$ – 1.5446
GBP/ZAR – 12.9247
GBP/JPY – 124.85
GBP/HKD – 12.1641
GBP/NZD – 1.9668
GBP/SEK –  10.9310

EUR: Market sentiments towards Europe improved notably on Wednesday, signaled by a rally in European periphery bonds with Spanish borrowing costs falling below seven percent level, a positive development ahead of today’s bond auction by the Iberian nation in the morning. The trigger for sudden surge in demand seems to be speculations surrounding the use of the bailout funds – the EFSF and the ESM, to buy bonds in the secondary market, a measure reiterated later in the day by German Chancellor Angela Merkel. The ongoing speculation, combined with the FOMC announcement due later in the day, pushed the single currency to its highest level against the greenback since mid-May. The GBP/EUR pair dipped to 1.2342 ahead of the Bank of England’s June monetary policy minutes that showed an unexpectedly close decision deferring further assets purchase, but the downside was restricted and the cable soon bounced back to 1.2400 levels. Focus today remains on European PMI numbers due in the morning and yield on Spanish bond auction in the morning. GBP/EUR opens at 1.2405 this morning.

USD: The June minutes of the BoE policy decision showed an unexpected rise in possibility for further liquidity injection with a 5-4 split in voting as Governor Mervyn King joined Adam Posen, David Miles and Paul Fisher for further QE. The need for QE was further highlighted by soft employment numbers, underlining UK’s fragile labor markets. The Pound slipped to 1.5650 against the USD although the lower movement proved fleeting and the cable soon hit 1.5777 against the greenback in anticipation of the FOMC announcement later in the day. The Fed extended its Operation Twist measure, through which it swaps short-term Treasuries with long-term bonds to keep borrowing costs low, till the end of the year. Fed Chairman Bernanke said the central bank is ready to do more if required, but fell short of announcing more aggressive measures like direct Treasury buying or QE3. US economic data calendar includes June Philadelphia Fed survey and existing home sales reading while May retail sales numbers are due in the UK today. The GBP/USD pair opens at 1.5678 this morning.



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