The euro surged on news that the European bailout fund will be given the power to buy periphery debt in the secondary market. We think this is a wise move by European leaders. It will chase out shorts in the bond market and spook CDS buyers. We anticipate buying to be unannounced (unlike the Fed’s QE).

 

The riskier part of the plan, which is a draft “Marshall Plan”, calls for EU investments and growth stimulation in Greece. Banks will be recapitalized with an estimated €25 billion via loans to the Greek government. The EFSF will issue loans at around 3.5% and the duration will be extended from 7.5 years to at least 15.

 

As the news leaked out, EUR/USD jumped to 1.4315 from 1.4190. Technically, it sparked an outside bullish reversal candle. The move above 1.4309 surpasses the 100-day and the 55-day moving averages.

 

At the same time, S&P said there is a 50% chance it will downgrade the US to AA in the next three months. They warned that a short-term agreement to boost the debt ceiling without a long-term deficit-cutting plan could cause the downgrade as soon as early August. Under this scenario, they see US long-term yields rising 25-50 bps with GDP growth also cut by 25-50 bps.

 

They said a failure to reach an agreement would likely shove the US economy back into recession. They think it’s possible the Treasury could delay other payments and push default beyond Aug. 11. The latest possible date they see is Aug. 15, when $62 billion in interest is payable.

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