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Euro Soars on Report that France, Germany Agree to Boost Rescue Fund

By , Currency Analyst
18 October 2011 19:38 GMT

THE TAKEAWAY: [France and Germany Ready to Agree to €2trillion Rescue Fund] > [Calm Market Fears of Contagion] > [EURUSD Bullish]

With just 90-minutes left in the trading day on Tuesday, higher yielding and risk-correlated assets were holding just below session highs, seemingly floating higher on relatively low volume once more. Markets remained below their session highs set last week after yesterday’s sell-off on commentary from the German leadership block that not much would be settled this weekend. Likewise, Moody’s Investor Service said that France’s top credit rating is under pressure. France’s ability to participate in any European bailout fund remains highly dependent on the core country’s ability to maintain its top tier credit rating; likewise, the future economic stability of the Euro-zone very much lies within France’s ability to contribute to European bailouts.

Despite these realties, on a report from The Guardian, higher yielding and risk-correlated assets, such as U.S. equity markets, the Australian Dollar and the Euro, found significant support and were bid towards fresh session highs. The report evoked similarities to the Financial Times report issued two-weeks ago – to the hour – that lifted equity markets and currencies from multi-month lows on October 4.

EUR/USD 1-minute Chart: October 18, 2011

Euro_Soars_on_Report_that_France_Germany_Agree_to_Boost_Rescue_Fund_body_Picture_1.png, Euro Soars on Report that France, Germany Agree to Boost Rescue Fund

Charts created using Strategy Trader– Prepared by Christopher Vecchio

Likewise, the response by markets was a clear move towards risk-appetite, with the AUD/USD and EUR/USD climbing over 80-pips following the report, and with U.S. equity markets hitting their session highs as well. At the time this report was written, however, the U.S. Dollar was climbing back, with the Aussie and Euro falling, as the report was vague and cited no informants besides generic ‘EU diplomats.’

The report noted the following:

On Tuesday stock markets and foreign exchanges reacted uneasily to the damping down of expectations, notably out of Berlin, about the prospects of a full-scale deal although EU diplomats close to the talks say the Franco-German agreement covers boosting the financial firewalls for Euro-zone members to withstand the threat of a "credit event" or sovereign debt default in weaker countries.

This takes two forms. First, the main bailout fund, the European financial stability facility, will be given additional levers enabling it to offer first-loss guarantees for bondholders, be they private or public. Senior diplomats say this will deliver a fivefold increase in the fund's firepower – giving it more than €2tn compared with the current €440bn lending capability. The EFSF will effectively become an insurer, thereby overcoming European Central Bank resistance to the idea of turning into a bank.

Second, Berlin and Paris have agreed that Europe's banks should be recapitalized to meet the 9% capital ratio that the European Bank Authority is demanding following its re-examination of the exposure levels of between 60 to 70 "systemic" banks. The EBA has marked these exposures much closer to current market values.

It is said that the overall recapitalization required will be closer to €100bn rather than the €200bn talked about by Christine Lagarde, IMF managing director, and others. French and German banks, senior sources said, can meet the new capital ratio target on their own without recourse to state funds, let alone the EFSF. Other countries' banks, however, may need financial support from the state or the EFSF.

Whether or not this report has the apparent credibility that the Financial Times report had remains to be seen. In the days following the Financial Times report, U.S. equity markets moved off of their yearly low, the Euro rallied from an eight-month low against the U.S. Dollar, and the Aussie jumped nearly 1000-pips against the Greenback.

UPDATE: DOW JONES REFUTES REPORT

EUR/USD 1-minute Chart: October 18, 2011

Euro_Soars_on_Report_that_France_Germany_Agree_to_Boost_Rescue_Fund_body_101811_eurusd1min.jpg, Euro Soars on Report that France, Germany Agree to Boost Rescue Fund

Charts created using Strategy Trader– Prepared by Christopher Vecchio

It now appears that another story is brewing. According to Dow Jones, the details of The Guardian report are incorrect, with sources completely refuting what was unveiled. The EUR/USD has slid sharply from its late-session bounce, and continues to face downside pressure in the post-market hours.

-- Written by Christopher Vecchio, Currency Analyst

To contact Christopher Vecchio, e-mail cvecchio@dailyfx.com.

Follow me on Twitter at @CVecchioFX

To be added to Christopher’s e-mail distribution list, send an e-mail with subject line "Distribution List" to cvecchio@dailyfx.com.

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18 October 2011 19:38 GMT