EU Summit: Expecting the unexpected?

The EU summit starting today will be the dominant force behind sentiment and positioning as we close out the week and the month. The starting point for debate seems to be the report from the President of the European Council, Herman van Rompuy – ‘Towards a genuine economic and monetary union’. A title that begs the question, what kind of economic and monetary union did the 11 founder (and 6 subsequent) members sign up to?

Van Rompuy’s report lays out 4 ‘building blocks’ for deeper eurozone integration:

• A European system to guarantee bank deposits and manage troubled banks
• Fiscal integration to exert greater control on national budgets and steps towards issuing joint debt
• More integration in economic policy making to boost competetiveness
• A more democratic accountability in European level decisions

All of which sound sensible and progressive, but the detail of how to actually build something with these blocks falls apart in the lack of detail. We have oft been treated with a lack of intellectual capacity as far as official eurozone comminications are concerned and this report, which is full of encouraging descriptive narrative but empty on specific detail (particularly in terms of ultimate liability or suggestions of actual amounts and rational as to their adequacy are concerned).

The big issue that remains unsolved by any suggestion that I have seen is that there is a finite amount of money within the system. Commentators, such as the Canadian Finance Minister, have oft remarked that Europe has the finances to deal with its own issues (a pointed reference to the fact that the Canadians, or indeed the Americans, did not contribute to the recent additional IMF funding) and on aggregate this may be true. However, Germany has made its position clear on the fact that it is not likely to accede to any form of debt mutualisation without greater control and/or political union. Hollande has made himself clear that France will not cede its Sovereignty lightly (likely a necessity to greater fiscal unity and control).

A smile for the cameras

The friendly unity that was ‘manufactured’ for last nights Merkel, Hollande meeting perhaps veiled the inherent differences of the two states, but clear statements to parliament yesterday from German Chancellor Merkel suggest that there is a long way to go before Germany will open the cheque book to the rest of the zone.

"I fear that at the summit we will talk too much about all these ideas for joint liability and too little about improved controls and structural measures" - Merkel

Power to the people

Much was made of the Greek elections where the people of Greece said no more to the austerity and hardship of the budgetary constraints that came with the bailout package, not only giving a seal of disapproval to the established political parties in Greece, but also providing a broader warning that politicians only hold sway while they have the popular support of the people. The power of the people may become apparent from the other side of the eurozone spectrum going forward as it has been suggested that further moves for Germany to back the debt piles of the weaker states may go to a referendum. The outcome of such a referendum is not obvious.

Volatility will likely pick up today and tomorrow as month end rebalancing amid rhetoric and comment from the EU summit tests the resolve of those holding positions. It is therefore likely prudent to have smaller and more nimble positioning during the short-term impact of these events. The data overnight was mixed with sentiment data continuing to come in on the weak side of expectations, but Japanese retail sales data were stronger than expected. There was also some evidence of position squaring EUR buying overnight. Yet while it may be prudent to reduce exposure into the week end, the potential for disappointment remains high.

Going forward falling oil prices will likely stabilise as production declines and inflation is brought lower, along with growth expectations (as highlighted this morning by the German Ifo institute suggesting Germany is “entering a weak phase”) and central banks will likely be more inclined to ease policy further (potentially supportive of equities). The risk in the short-term is that some form of compromise is reached to kick the eurozone can further down the road. But the procrastination and divergence within the zone have already had a huge negative impact on the future growth trajectory of the zone and any temporary boost to eurozone prospects in the short-term still remain, to me, opportunities to sell for the medium to long term.