Coordination success in EU - potential for easing of credit crisis

The EU met over the week-end to hammer-out a European coordinated response to the credit crisis. The G7 meeting was not a success in terms of developing specific actions items. The negative response to the lack of specific action steps made the EU heads of state and finance ministers meet in Paris to discuss a European solution.

The EU followed the road map set by the British to guarantee inter-bank lending and inject cash into the banking sector. In Great Britain, the capital injection will partially nationalize the major banks and require a change of management. Australia also has formed a bail-out plan. The US TARP plan looks like it will provide for investments in bank equity. At this time, the markets have taken this level of coordination as a significant positive but we have not seen the financial world open for all money market transactions.

The key to this coordination will be what happens to spreads in inter-bank lending. The guarantee of the funds is the most important component of the plan and was the consensus approach of many leading financial economist. If LIBOR and TED spreads close then we should see a sustained rally in equity to the levels in the market around the Lehman collapse.

However, the focus of the market will switch to earning so it is unlikely that we will see summer equity levels. For the FX market, the country economics will drive currencies. The dollar will weaken, but we do no see a significant reversal to dollar lows because deleveraging is still putting downward pressure on the Euro and the global economies are still weakening. Some strength will be seen in emerging markets which have strong economies and weree hit hard by portfolio outflows.