20th EU crisis summit triggers rally in precious metals

At the 20^th EU summit since the start of the debt crisis, it seems that the European politicians finally learned the lesson and moved in the right direction. Before the start of the summit, markets traded down as the rhetoric of German politicians indicated that this summit would be a complete failure. However, after many hours of negotiations, a breakthrough had been reached on Friday in the early morning hours. Risky asset markets, stocks and commodities, rallied. Yields on eurozone peripheral government bonds came down, but it was a roller-coaster ride. Safe haven government bond prices dropped like a stone at but later pared a major part of initial losses. The push on the last trading day of June was so strong that most precious metals ended the weak in the plus, only palladium closed lower than the Friday before.

Germany’s iron chancellor, Mrs. Merkel, is also known as Madam No because she rejected all proposals, which were suitable to mitigate the pressure on Spain and Italy in financial markets. The narrative of her policy is a widespread misperception in Germany that the peripheral eurozone countries were sinners, which have to be punished for running too high budget deficits. Ahead of the summit, her rhetoric got even more aggressive by stating that common Eurobonds would not be introduced as long as she lives. Thus, it appeared that Mrs. Merkel would not move even one inch from her position and the EU summit would end in a disaster. However, many analysts and strategists in the City of London are performing only mediocre in analyzing political negotiations.

After the summit, a session of the German parliament was scheduled with a vote on the fiscal compact and the ESM on the agenda – both votes reached the necessary majority. As a modification of the German constitution was necessary, both topics on the agenda required a two-thirds majority. The coalition government has only a simple but not a qualified majority in the lower house. Furthermore, parties supporting Mrs. Merkel’s government do not have the majority in the upper house. Thus, Germany’s iron chancellor needs the backing of the two main opposition parties for changing the constitution and pushing the vote on ESM and fiscal compact through both houses. One pre-requisite for the support from the social democrats and environmentalists, the greens, was that the EU also agrees on a growth stimulus package at the summit. Thus, Mrs. Merkel could not afford that the EU summit would end without the growth initiative designed together with the French president and the prime ministers from Spain and Italy.

While the high paid analysts and traders in the City of London overlooked this detail of domestic German politics, Messrs Rajoy and Monti did not. Thus, the prime ministers of Spain and Italy threatened to veto the EU growth pact. Germany’s chancellor had to make concessions. And for Europe, it was worth to give up resistance. The major breakthrough was cutting the link between bailing out banks and escalating government debt to GDP ratios. Direct bailouts of banks without increasing the debt of national governments will be possible.

Furthermore, investors dumped Spanish government bonds and pushed yields up after EU finance ministers decided to provide up to 100bn euro for recapitalizing Spanish banks. Normally, a bailout led to senior debt status of official lenders over private creditors. This rise in yields on Spanish government bonds increased the risk that beside the banks, also the government might need to be bailed out by the EFSF and the ESM. With the decision that the recapitalization of Spanish banks would not lead to a senior status of bailout loans over the private sector, yields came down and the risk is reduced that the Spanish government would not be able to obtain funds in bond markets at reasonable costs.

Another important step has been the agreement on a more flexible use of eurouzone rescue funds. Countries meeting the EU deficit criteria could ask for help to buy government bonds and thus to keep yields on the country’s bonds at an affordable level. Especially Spain and Italy could profit from this agreement without having to undergo the imposition of austerity measures by the troika.

These measures are important steps forward. However, more measures would have to follow. These include the creation of a single eurozone banking supervision and a banking union with joint deposit guarantees. A single currency area also requires a single financial market. The current crisis and fears of a failure of the euro has led to a tendency towards segregated national financial markets again. Furthermore, a movement towards a fiscal and political union as a medium-term target has to remain on the agenda.

The EU summit has surprised with positive results heading in the right directions. The crucial question is now, how long will the improvement in investor’s risk appetite last? If the initial impact is not petering out quickly, stock markets might head higher and the euro could recover further against the US dollar, which would be supportive for precious metal markets. This could also improve the sentiment in major economies. However, the risk is that analysts and strategists turn negative on the EU summit results in reports published over the weekend. Also economic data is likely to come in week in the short run. If investors will be more concerned about past economic data than the improved outlook for solving the eurozone debt crisis, then risky assets might head lower again over the summer months and this would apply also for precious metals.