"Springtime For The Euro, Then Reality" - Citi Summarizes What Happened In Europe, And What Are The Next Steps

Citi's Steven Englander summarizes last night's 4 am Eurosummit announcement, the kneejerk reaction in the all-important EURUSD, and what to expect both over the immediate future and the longer term:

From Citigroup:

Springtime for the euro, then reality

The nice thing about 4AM press conferences is that no one expects or wants them to be long. The agreement eurozone leaders reached with each other and the banks contain the following points:

1) Nominal write-down of 50% (EUR 100bn) of Greek debt in private hands; Greek debt owned by official lenders not touched
2) Remaining Greek debt will be refinanced at preferential rates
3) Bond swap to be done by end-January
4) Closer supervision of Greek adherence to the program
5) EFSF to be levered 4-5 times
6) No ECB involvement in EFSF; but EU officials were hopeful that they would decide to remain supportive
7) President Sarkozy will speak with China on EFSF involvement
8) EFSF will have both a direct insurance and SPV element; looking for EM/IMF support for the SPV
9) Estimates of EFSF firepower ranged from EUR1.0-1.4tn
10) Italy to deliver specific budget and deficit reduction program
11) Banks must meet minimum capital requirements, seek private capital to cover shortfall
12) If private capital raising insufficient, national governments and then EFSF to meet banking sector needs

The full text of the EU Summit statement can be found here: http://consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/125644…

Overall there was very little that had not been discussed earlier. The euro rallied but the rally did not seem based on much new information since there are very few details and the agreements are to be finalized in the next few months.

We would expect the next 24 hours to be driven by how the Sarkozy call to China President Hu Jintao goes, how investors analyze the sustainability of Greek debt under this program, and the reception that the EFSF proposal will get. We are a bit surprised by the enthusiasm given the lack of detail and lack of surprise. We are also wondering how seriously investors will take the EFSF guarantees (which only apply in the event of a default), given that the banks were strongly encouraged to declare the current restructuring voluntary. Investors may fear that the EFSF - guaranteeing - governments will similarly contrive to avoid paying out on their first-loss guarantees.

For FX, we see this as broadly positive for risk, since the package seems adequate to avoid any euro zone driven financial market catastrophe for the next year or possibly longer, but it is probably not enough to improve euro zone growth prospects a lot and there are a lot of loose ends that could unravel. We continue to prefer small G10 currencies with good fundamentals (CAD, AUD, NOK, SEK, NZD). We think they will be supported by macro policies in the US, UK, Japan and China (if needed).  We also note with satisfaction that investors have forgiven CAD and AUD for dovish central banks and weak CPIs -- we think that they will continue to be bought more on risk than off rate differentials.

We doubt that this package can bring long-term support to the euro, even as we note that there are a lot of committed USD sellers out there. There is a risk of running stops to the upside, as positions still seem somewhat short EUR, but we don't think this package can sustain major gains unless outside money is more enthusiastic about backing euro zone debt than either the ECB or euro zone governments seem to be, and we are not sure why this should be the case.