FOREX: US Dollar Sold as EU Summit Outcome Boosts Market Confidence

Talking Points

• EU Summit Delivers Broadly as Advertised but Many Specifics Still Undecided
• Japanese Yen Falls as Bank of Japan Expands QE Measures by ¥10 Trillion
• All Eyes Now on US GDP Data as Global Growth Outlook Returns to Focus

After much speculation and feverish negotiations that dragged long into the night, European Union leaders finally unveiled the details of a yet another “comprehensive” plan to contain the sovereign debt crisis plaguing the regional bloc since late 2009. Near-term measures amounted to three broad initiatives:

1 – Greece will reduce its public debt to 120 percent of GDP by 2020, with private investors agreeing to a voluntary bond swap that will wipe away 50 percent of the country’s obligations. Euro Zone member states will contribute up to €30 billion in additional capital while the “official sector” – presumably the EU – will provide additional financing up to €100 billion, for a total of €130 billion in new aid. Details of the new program are to be established by the end of the year and the bond swap initiated by early 2012.

2 – The European Financial Stability Facility (EFSF) will be leveraged by up to 4-5 times for a total lending capacity of €1-1.4 trillion through primarily two approaches: Euro Zone member states will offer insurance to buyers of bonds of debt-strapped countries, reducing risk premiums and funding costs; a Special Purpose Vehicle (SPV) fund will be established to funnel money from private and public investors – notably sovereign wealth funds of countries such as China – toward the purchase of ailing countries’ debt. Further EFSF enhancement will be sought through cooperation with the IMF.

3 – To help reinforce the structural integrity of EU banks, lenders will be required to meet a capital reserve requirement of 9 percent, equivalent to €106 billion, to be attained by the end of June 2012. National regulators and the European Banking Authority (EBA) are to ensure that the process is not so rapid as to result in mass bank asset sales and a scarcity of credit in the real economy. Banks are to increase capital on their own, turning to national governments and the EFSF as a last resort, in that order. Lenders will also be subject to bonus and dividend restrictions until their reserve requirements are met.

The US Dollar traded broadly lower following the announcement, down as much as 0.7 percent against its sentiment-linked counterparts. S&P 500 stock index futures are pointing aggressively higher in late overnight trade, promising more of the same in European hours. The greenback’s decline against the Euro has been conspicuously modest however, hinting the single currency may find itself under pressure as the fundamentals of growth and interest rates return to the forefront. The Japanese Yen likewise sold off after the Bank of Japan expanded monetary stimulus by a cumulative ¥10 trillion, splitting the sum between its asset-purchase fund and credit program. The credit-load program was left unchanged at ¥35 trillion.

On the data front, all eyes are now on the third-quarter US Gross Domestic Product report. Expectations call for output to rise 2.5 percent in the three months through September, marking the strongest performance in a year. The outcome would confirm that the US recovery is gathering steam, warding off fears of a double-recession. Importantly, it is unclear whether the outcome will prove supportive for risk appetite in terms of improving the outlook for global growth or detrimental in that stronger US performance undermines the case for additional quantitative easing (so-called “QE3”). The preliminary set of October’s German Consumer Price Index figures is also on tap, with the annual inflation rate set to hold steady from the previous month at 2.6 percent.

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--- Written by Ilya Spivak, Currency Strategist for Dailyfx.com

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