Panic Abates, Markets Rally - Can the Euro Also Participate?

European bankers and finance ministers, prodded by comments from the international finance luminaries at last weekend's Washington gathering, took the message home that it was time to take action to address the euro banking crisis. Specific details of these new solutions remains elusive, but markets have embraced the concept that help is on the way.

The buoyant market physic has been especially helpful to the European bourses. Yesterday the German DAX average was up 5.29%; in Paris, the CAC 40 Index was up 5.74% and the OMX Stockholm 30 Index was up 6.22%. One of the proposals is a central bank which would take the banks toxic debt and, in return, gives the banks euros to recapitalize failing banks.

The ECB has already been involved in such a process, buying € Billions of shoddy debt, and helping the weaker banks. This is an evolving process with many unanswered questions. Will the ECB be the organization that will supervises the expanded activity. Is this not a European version of TARP, designed to save the politicians and the financial class, but which devalues their currency and hurts those less privileged. Such a plan may save banks, but this is not an economic stimulant.

The banking crises might be solved but how will this serve to reduce government deficits? Or what does this do to overcome a failing concept that one currency is best for all seventeen countries. And how will this do anything to improve the inefficient countries?

There are other unresolved issues. The Greek insolvency crises will continue. Do you continue support a country that refuses to reduce the size of the bloated government payroll, subsidize the government that refuses to dispose of poorly run government enterprises? Politicians supporting such activity are risking a career change.

The Germans, together with the French have been the biggest defenders of the sanctity of the euro. On Thursday the Bundestag will vote on a provision to expand the size of the European Financial Stability Fund. (EFSF) Passage of the bill would increase the German contribution from €123B to €211B. Within Chancellor Merkel's Christian Democrat party there is resistance to the plan, and defeat of the proposal would hurt Merkel and her defense of the euro.

Can the Euro Rally?

After the extended sell off from over 1.45 to almost 1.33 during the last month, this market can rally, and it may be larger than expected. As we noted in the latest COT report the specs are now short 102.7K euro futures contracts, so a short squeeze could give us a bigger than expected rally. We must point out, however, 75K of the short contracts are in the hands of the big specs, and when it comes to reading the market tea leaves, this group is the best.

Yesterday's market action has some elements that may portray a reversal. The candlestick, with a small body and a long lower wick. It traded at a new low and then rallied to close higher, for a reversal day. Today, with the trade higher, this seems to be confirmation, the market tone is changing. Where might there be some buy stops? My guess is they might start a little above the 1.37 handle. Our preference is to trade the euro from the long side at this time, but caution is advised ahead of the German vote.

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