The Euro rallied 2% today against the USD causing a sharp reversal of crisis-fearing “risk off” trades which have been working against all financial markets around the world. The Euro rallied based on indications that France and Germany are going to work seriously towards recapitalization of the European banking sector. This has been one of the two necessary conditions for the confidence to return to Europe:
1) Sovereign debt crisis needs to be contained by capping interest rates for countries like Italy, Belgium, and Spain. This was the easy part because for now the ECB has the authority to buy the debt to cap rates. Eventually the EFSF will be expanded and debt will be purchased through this vehicle.
2) The financial system in Europe needs to be able to fund itself. The announcements today that Merkel and Sarkozy have outlined a new blueprint to recapitalize the banks is the first very clear admission that something needs to be done and creates the feel that Eurozone leaders are getting “less behind” the crisis.
The result of this announcement of a plan (or really a need for a plan) has been somewhat neutral for European financials. This is sensible because many banks in Europe are going to need to raise equity capital or sell assets.
Although this is a stabilizing factor for Europe it is bullish for US financials. Banks in the US are already well capitalized and have been trading to super-depressed levels (based on normalized price/book ratios) because of fears of Eurozone exposures. A recapitalized European financial system lessens the risks dramatically for US financials related to European sovereign debt holdings and loans to the corporate sector.
It isn’t a surprise that while large banks in Europe such as Soc Gen, Credit Agricole, and Santander are trading unchanged the financials in the US are ripping higher. Since the financials have been the huge underperformers on the way down this outcome is quite bullish for the S&P 500. All of this continues to solidify the base the S&P 500 put in at 1,100. Today’s moves in the first hour for the major US financials:
- Bank of America (up 5%)
- Citigroup (up 5%)
- JP Morgan (up 4.5%)
- Goldman (up 3.5%)
- Morgan Stanley (up 6.5%)