Markets Surge on Positive EU Summit Outcome

NEW YORK ( BBH FX Strategy) -- Global stock markets continue to surge after news that European policy makers had forged an agreement at the emergency summit. While we expect this is unlikely to resolve all fundamental challenges that plaque the euro zone, the outcome of the summit is likely to have satisfied market expectations.

As a result, EZ spreads have come in sharply, European banking shares are 7% higher and the dollar is softer across the board.

On the data front, euro zone Economic Confidence fell much less than expected, eurozone M3 money supply growth accelerated more than expected, and the UK CBI Distributive Trades Survey also came in above consensus. German inflation is expected to remain unchanged at 0.1% month-over-month. Elsewhere the Riksbank left the repo rate steady at 2% and expects to resume tightening next year.

Follow TheStreet on Twitter and become a fan on Facebook.

Policy makers did a good job of downplaying expectations ahead of the summit. Above all, we view the subsequent price action as a reflection of positioning rather than euphoria about the resolution of the crisis.

Nevertheless, the summit produced the three-pronged plan that includes 50% haircut on Greek debt, a deal on bank recaps and a "top up" in the firepower of the European Financial Stability Facility (along with guarantees which only apply in the event of a default). Greece will also get an additional 100 billion euros in cash, also to finance the recapitalization of banks.

Based on initial projections, the haircut should allow Greek debt to be reduced to around 120% of GDP in 2020. The authorities agreed that involvement is voluntary, excluding the default scenario. Meanwhile, the 220 billion euros of the EFSF that are not already earmarked so far will be leveraged to 1 trillion euros, through bond insurances and the creation of special purpose vehicles to attract outside investment.

China and other cash rich emerging markets have already signaled interest but overall EU leaders expect the EFSF framework to be ready by the end of November. What's more banks will be required to lift the core capital ratio to 9% by the middle of next year, with estimates suggesting that this will require 106 billion euros of fresh capital. Most banks should be able to handle this but Greek banks in particular this will be difficult, which will put further pressure on the Greek government. Banks have until Dec. 26 to specify details of how they plan to raise additional funds, with national governments and the EFSF the ultimate backstop.

In the near-term, we do see this plan as broadly positive for risk appetite and coupled with the recent upsides surprises in U.S. data and the potential for more accommodative policy from China, this could see growth sensitive currencies (CAD, AUD, NZD, SEK, NOK) extend their recent rally, even though we expect that the risks to the euro from here are to the downside.

At the same time if today's third-quarter U.S. GDP report delivers a strong result it has a chance of taking the S&P and risk sensitive currencies with it. AUD in particular should thrive on this news despite the potential for a rate cut, given the market has already discounted nearly four 25-basis-point rate cuts from the Reserve Bank of Australia over the next year.
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.