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Have the markets over-reacted to the Euro-zone deal?

Have the markets over-reacted to the Euro-zone deal?
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First Published: Mon, Oct 31 2011. 08 43 PM IST
Updated: Mon, Oct 31 2011. 08 43 PM IST
The Euro zone deal and strong US September quarter GDP numbers (up 2.5%) sparked a rally in equity markets across the globe. The Sensex surged 6.1% last week. While S&P 500 rose 3.8%, the MSCI Europe Active contract registered gained 6.2% in five trading sessions.
Analysts, though, are not too optimistic.
The Euro zone deal, which proposes to boost the rescue fund by one trillion euros amongst other measures, is a step in a right direction. But it does not have the capacity to hold back the region from slipping into recession.
J.P. Morgan said in a note dated 28 October: This summits defines the start of the end of the sovereign debt crisis, but that this process will be drawn out (likely in years), will have reversals... will not be obvious for some time, and will not prevent Europe from falling into recession again, as banks deliver and austerity bites hard.
The note goes on to add further: If the EU Summit were the only reason to be long risk assets, then we accept that we may be on thin ice.
For all its flamboyance, the deal is still short of details. It is not yet clear how the member countries will fund the rescue facility. Also there is no contingency plan if the situation deteriorates further.
Nomura said in a note dated 28 October: An important drawback of the plan is that it offers no clarification on the continued involvement of the ECB in secondary market operations. Actually, if anything, more questions have been raised in this week’s Bundestag call for the ECB to end its bond buying programme once the enhanced EFSF is up and running. If bond buying by the EFSF SPV facility is meant as an alternative to the ECB’s SMP (Securities Markets Programme), then we doubt whether it can perform the tasks as efficiently as the central bank. That is a concern. But in any case, this issue is unlikely to be cleared for several weeks.
The excruciating delay in chalking out a crisis plan might have already cost the euro economy dearly. According to Reuters, the flash Markit Euro zone composite PMI, which measures business activity of manufacturers and service sector companies, contracted to 47.2 in October from 49.1 in September. While this is second consecutive month of decline, analysts are worried that recession in Euro zone has already started. Euro zone recession may have already started: PMIs.
Even as the US economy sprung a surprise by delivering strong GDP growth in the September quarter, the country still faces significant economic stress in the form of a high unemployment rate and sluggish housing industry.
For India, the continuation of economic stress in the US and contracting economic activity in the Euro zone could mean more listless trading sessions like the one we have witnessed today. Sensex falls in listless trade...HUL jumps
Needless to say, India faces it own problem in the form of high inflation and high interest rates even if the Central bank has indicated a pause in tight monetary policy for now. The flagging economic conditions in the west will hit exports while the government deficit might crowd out private sector borrowing.
While the rally in the European stock markets fizzled out (European Stocks Fall, Paring Best Month Since 2009), it requires more than the namesake deals for the investors to turn structurally positive on equity markets. In short, risk aversion still exists.
J.P. Morgan notes: Much has been written about how the EU Summit Statement is full of vague promises and short of concrete details, while glossing over still large disagreements between major stakeholders. We do not disagree. The next few weeks and months will likely see a seesaw in perceptions of whether this new plan will do the job.
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First Published: Mon, Oct 31 2011. 08 43 PM IST
More Topics: Markets Update | Euro Zone | Sensex | Stocks | Dollar |