Break in EU Clouds Welcome News, But Volatility Far from Over

News of progress in the euro-debt remedies cheered investors around the globe. Several measures take the pressure off the underlying risk factor that has cast a long shadow over the global economic recovery – contagion. Germany’s agreement to allow direct injection of euro bailout capital into troubled banks, treatment of aid for Spanish banks as equal to existing bond holders and easing of government bond buying restrictions comprised a major turn in European dynamics, which quickly brought down the cost of borrowing for Spain and Italy. At the same time, European leaders have agreed to central supervision of eurozone banks, tightening the bond among member nations and, in theory, applying a more consistent approach to resolving financial crises and liquidity shocks. These steps relieve short-term concerns of the spread of Europe’s banking crisis by providing much-needed liquidity and at least partially stemming further economic contraction. On a longer-term basis, assuming a consensus regarding the details of the agreement, a more central management of the banking sector should assist in a systemic resolution of the European debt crisis.

As I have shared in previous blogs, here in the United States, economic fundamentals have been stronger than the numbers would suggest for quite some time. I have also taken the view that a more robust, organic expansion has not formed largely due to a lack of confidence by corporate America and a high degree of lingering uncertainty, both of which have been significantly influenced by negative macro headlines. The recent loss of momentum in vital U.S. economic readings drove the Fed to extend Operation Twist (selling of short-term bonds and purchase of long-term bonds) to keep interest rates at generation-low levels as a way to shore up the recovery. Notwithstanding the Fed’s move and the disappointing trend lines that led to it, the U.S. economy is on improved footing and could gain momentum relatively quickly should corporate and consumer confidence improve.