Jittery Optimism Likely Into Weekend

NEW YORK ( BBH FX Strategy) - Investors remain nervous but cautiously optimistic going into this weekend's eurozone summit. Indeed, risky assets are mixed in part from confusing headlines from the eurozone, including announcing another summit for Oct. 26, despite the continued improvement in U.S. economic data.

Ahead of the Asian session, markets rallied on the back of a fresh proposal suggesting that the increased firepower required would be achieved simply by combining the lending power of the European Financial Stability Facility (440 billion euros), with the European Stability Mechanism (500 billion euros). Admittedly, this would not be a quick fix since it would require a change in the treaty and thus would need to be voted on by all member countries.

Nevertheless, eurozone stocks are higher on the day with the benchmark index led by the 1.7% rally in banking shares. Canadian CPI exceeded expectations, suggesting the Bank of Canada is likely to remain on hold.

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There is little doubt that this weekend's first of two summit meetings is likely to be the main event over the few days. As such, we expect markets to remain jittery and for price action to remain choppy, given the difficulties policy makers have in solving the eurozone debt crisis.

Market expectations are likely to hinge on a package with three potential elements. Many suspect a program for bank recaps to be announced with recent estimates from eurozone policy makers suggesting banks may need upwards to 100 billion euros. Next, is increasing the size of the haircut on Greek government debt, with possible write-downs in the range of 40% to 60%. And finally, some observers believe that it is likely that euro zone policy makers bring forward the operation of the ESM (set up to replace the EFSF and deal with orderly defaults) to mid-2012, rather than 2013.

While we think these measures would likely be a step in the right direction, we suspect that they solutions are unlikely to provide closure for the markets and thus we expect the markets to be disappointed in the outcome. As a result, we see near-term downside potential for the EUR-USD but expect the currency to remain within its current range.
This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.