By Christopher Vecchio, Junior Currency Analyst
Talks between French and German leaders have led to a wave of parliamentary action across the Euro-zone's members to expand the European Financial Stability Facility (EFSF). The EFSF has been compared to the United States' Troubled Asset Relief Program, as one of the last remaining hopes to keeping the Euro-zone, and thus the Euro, intact. The following is a brief overview on the EFSF in its current form and how it functions, as to better understand why markets react negatively or positively on EFSF related news.
On July 21, a brief wave of optimism spread across financial markets as European leaders unveiled an expanded European Financial Stability Facility (EFSF), designed to save Greece from defaulting on its debt obligations. Originally created by Euro-zone member states in 2010, the EFSF is a rescue package with the "objective of preserving financial stability of Europe's monetary union by providing temporary financial assistance to EAMS in institution." Within TARP, different measures were formed to "stabilize and recapitalize the financial system, restart the credit markets, restore confidence and lower borrowing costs for businesses and billion." Additionally, the EFSF is not a collateralized debt obligation which means "there is no seniority and all investors have exactly the same rights," unlike the TARP, which covered collateralized debt obligations.
As the European debt crisis intensified over the past month, the original EFSF was deemed insufficient and flexible enough to offer the bailout support debt ridden countries would need to avert a default. New powers were added to the facility including "the ability of lending to governments for bank recapitalization and precautionary credit lines before they are shut out of markets" that make the EFSF more like TARP. "The new deal also lowers the interest rates on current EFSF loans to Greece, Portugal and Ireland by between 100 and 200 basis points, and extends maturities on those loans out to 15 ability to secure 'sick' assets and shore up European debt markets.
Similarly, after a weekend of meetings between French President Nicolas Sarkozy and German Chancellor Angela Merkel, in which plans to save the Euro-zone (via the EFSF) were discussed, the EUR/USD rallied nearly 300-pips. The rally was a near-straight line higher for the Euro across the board on Monday, as shown by the chart above.
Based on the reactions we've observed, there is a simple conclusion to make: talks of an expanded EFSF and further efforts by Euro-zone officials is enough ammunition to drive the U.S. Dollar lower and the Euro, as well as other risk-correlated assets, higher. Going forward, on further positive developments out of Europe in regards to the EFSF, the EUR/USD stands to gain further. Should not further developments occur, and these talks about to little more than just words, the EUR/USD would be poised to move lower.
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