M.F. Euro Takes Down Equities

By Global Macro Monitor

Lots of debate out there what took the market down today. We’re not certain you can tag the first 15 S&P points on a single factor — MF Global, euro, Italy, yen intervention and strong dollar, or simple profit taking — but willing to up our bet the last 15 points, which began around 2 PM, was the floppy Euro. The news that Greece will “hold a rare national referendum on a new debt agreement” hit right around 2 PM. Take a look at the first chart.

Though some place the blame on MF Global dumping positions, which we doubt, markets are growing increasingly concerned as the Italian 10-year bond yield has spiked to over 6 percent in the past few days, up from 5.87 percent prior to Thursday’s EU Summit deal announcement.

Markets have honed in on the one part of the deal that is most ambiguous — the bolstering of the EFSF. Japan and China waffled over the weekend on committing resources to the Euro debt bailout and as the Economist writes,

So we turn to the EFSF. Here is the biggest problem facing European leaders; they want to let Greece default and to stand behind Italy and Spain, without making a specific pledge that would upset their domestic voters.

The EU leaders really desire a magic “money tree” which would come up with a new source of wealth to deal with this issue. The French hoped that the European Central Bank would act as the tree, guaranteeing all Italian and Spanish debt. The Germans vetoed the idea. Of course, the ECB has no “wealth” of its own; European governments stand behind it. So an ECB bailout would be another back-door way of having the rest of the euro-zone support Italy and Spain, but without telling the voters.

The Euros will have to find a way — and soon — to come up with a hard number and clear path to the big bazooka EFSF to head off contagion to Italy. This whole exercise is about restoring confidence because that is what, at the end of the day, drives sovereign credit fundamentals. If Italy blows, game over.

We’re a bit surprised, and a little poorer, how quickly the market has loss faith in the European deal. Markets were overbought, so some profit taking is not surprising. But 6 percent plus Italian bond yields worry us.

Note also the Euro is now trading below where it was when the deal was announced on Thursday. Exit Trichet, enter Super Mario. The Fed begins their two-day meeting tomorrow. Lots of moving parts.

The S&P500 needs to hold its 100-day at 1230. Gonna’ get interesting.