EU Members Seeking “Enhanced Cooperation”

The EUR USD begins the week under pressure and in a position to smash through the October bottom at 1.3145 on its way to a test of the low for the year at 1.2873. The only thing standing in the way of this event occurring seems to be the small army of bottom-pickers out there trading the market using oversold indicators. Fundamentally, it appears that the European Union finance ministers have lost all credibility due to their inaction and inability to come up with a manageable plan to stop the spread of the sovereign debt crisis throughout the Euro Zone and other core European nations.

The close near the low for the week suggests this trend is likely to continue next week unless some major development occurs over the week-end. What did break over the week-end was the news that Euro Zone nations are considering a plan to accelerate the integration of their fiscal policies. This plan includes creating treaties between individual countries rather than create one treaty with the EU. This will speed up the process in which European leaders gain new powers to enforce fiscal discipline or financial austerity.

The plan being considered by the Euro Zone governments is based on the Schengen agreement. It was used before when a small group of EU countries decided to scrap passport controls. According to the agreement EU members are allowed to engage in “enhanced cooperation”. This will allow Euro Zone members to make treaties with other members, cutting out the process of having the entire Euro Zone approve changes to its treaty.

This pact could be announced before the EU summit on December 9, but will the market pay any attention to this announcement? Given the track record of the EU in reaching actionable agreements, many traders may choose to ignore this proposal unless it results in a short-term manageable plan to stem the spread of bad debt across the Euro Region. If implemented this plan will not negate the need for a longer-term agreement, but it will allow the EU to enforce a few of the changes it needs now to implement short-term austerity actions such as the stricter enforcement of budget rules.

This plan, in my opinion, is not going to stem the crisis of confidence taking place in the financial markets at this time. It may put in a short-term bottom in the EUR USD, but that may also occur simply because of oversold conditions. Euro Zone officials are hoping that the change in the European Central Bank leadership along with this new plan will encourage the ECB to step up its buying of government bonds in countries with sovereign debt issues.

Interest rates continue to rise in Italy despite efforts by the ECB to support the bond market. With investors leaving these debt markets in droves, continual central bank intervention is needed to prevent interest rates from sky-rocketing. Last week’s spike in interest rates following a debt auction in Italy was proof that unless the ECB steps up its intervention, the situation will continue to spiral out of control. Current conditions suggest that Italy has been lost.

Although the ECB has been doing what it can to stem the flow of sovereign debt with its bond purchases, the call for greater intervention couldn’t be greater. Increasing its influence in these markets runs the risk that it breaches its charter and ruins its credibility. After all, the role of the ECB is to control inflation not rescue debt-laden countries or troubled banks.