Risk currencies soared in Asian session today as EU summit produced an agreement amongst members to recapitalize the banks directly via ESM while making the ECB the central banking supervisor for the region. Given the negative rhetoric ahead of the event and the low market expectations going in, the EU summit surprised to the upside as lawmakers agreed to take concrete policy steps to address the chronic credit crisis in the EZ.
Policymakers at the EU summit agreed that the EFSF funds will not be senior to Spanish sovereign debt, that the bailout conditions will be relaxed without the absolute need for Troika overnight and that the roadmap for further integration will be laid out at the next summit in October. The immediate impact of those decisions was felt in the EU credit markets with Spanish long term bonds falling by -49bps while Italian bonds declined -39bps with the short end of the curve falling even more. The news should prove to be relief to Southern European economies which were facing crisis funding conditions ahead of the summit.
In the currency market the initial reaction caused a spike in all the risk FX pairs with EUR/USD soaring to 1.2625 in the aftermath of the announcement but the rally has stalled in to the European open as short covering exhausted itself and fresh buying disappeared. One key concern of most market participants is that despite the structural reforms agreed to at the summit. the region is still facing a daunting task to jump start growth and may require further monetary and fiscal stimulus to begin its recovery. Nevertheless, despite the initial skepticism the EU summit achieved far more than was expected and will likely stabilize the EU credit markets providing support for risk FX in the process.