Some positive developments in Europe

We are seeing some positive developments in Europe which could lead to a more sustainable solution to the European crisis.

The first positive indication came from the new ECB chief Mario Draghi last Thursday where he indicated that if there is a wide agreement on some stringent fiscal requirements among the EU nations, then the ECB could play a larger role in dealing with the European crisis.

The other positive development came today. It appears France and Germany the two most influential member of the EU are finally converging on how they want to handle the European crisis. Looks like they are calling for modifying the European treaty to include more stringent fiscal requirements which will limit the level of fiscal deficits a country is allowed to have. Till now France and Germany were on a different page with France calling for more ECB intervention without much constraints. It appears France is finally moving more towards the German position and setting up a system which closely resembles the one that Draghi wants in place for the ECB to play a larger role.

In response to these developments, you are seeing a strong pullback in most European bond yields, especially in those of Italy and Spain. The level of pullback is pretty large, which tells me the market is also thinking something more sustainable could happen. Also another positive development is that the new Italian government led by Mario Monti passed tough austerity measures.

The EU leaders have a summit on Dec 9th and we will find out more on how the proposal by Merkel and Sarkozy is received by everyone else.

The key thing now for the world equity markets over the next 6 months to a year is if this solution is too late. It appears Europe is heading into a recession, so are we going back into a negative feedback cycle where lower tax receipts make the fiscal situation worse.

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