Euro Hits Fresh Highs as German Court Rules Yes

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The German constitutional court approved the ESM mechanism, clearing the way for European governments to support the sovereign debt markets of the periphery economies, which helped to lift the EURUSD to fresh four month high of 1.2900 in moring European trade. The news helped to lower the yields on both Italian and Spanish sovereign debt with Italian 10 year bonds dropping below the key 5% level while Spanish bonds compressed to 5.6%. Only a few weeks ago Spain’s bonds skyrocketed above 7% creating a state of crisis in EU.

The German court ruling contained one key stipulation limiting the German contribution to the ESM to 190 Billion euros which was the original sum in the proposal. Any further funding would require the parliamentary approval of both German houses. The ESM structure as it stands now clearly does not have the scale to backstop any serious bailout needs for either Spain or Italy, but the markets seemed unperturbed by the ruling as most players believed that if further financing was needed the Bundestag would approve it or better yet the ECB could effectively take the bonds off the ESM balance sheet effectively recapitalizing the fund.

Since the ECB has committed to open ended buying in the secondary market and the ESM is approved to buy in the primary market the European policy makers could combine the two to create an “unlimited” conduit for liquidity in the region’s sovereign debt market capping the financing costs of the beleaguered periphery credits. Although this was clearly not the intent of the German constitutional court it does provide a much greater degree of flexibility for monetary officials to contain any further market disruptions in the credit markets and should help both Spain and Italy to complete its financing for the year at markedly lower costs than prevailed just a few weeks ago.

After some initial volatility, the EURUSD rose to session highs, but was capped at the 1.2900 level for the time being. Focus will now turn to the Dutch elections where expectations are that the voters will generally express a pro-euro view. Although much of the news appears to have been priced in, the momentum remains on the side of the bulls and euro could push to teh 1.2950 level as the day progresses.

Boris Schlossberg
Managing Director

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