high expectations heading into eurozone summit

The market is currently in limbo land adopting a “wait and see” approach ahead of the important EU summit on June 28-29th. Historians will one day look back at this summit as defining, because Europe really is now at a crossroads of utmost importance. The agenda will be broad and should range from specific steps toward cross-border banking union; closer fiscal integration; to the possibility of a debt redemption fund – all hopefully leading ultimately to greater fiscal and political union over the longer term.

Typically in the past few years, these European summits have attracted much hype and optimism, but have and delivered little with markets continuously disappointed.

Needless to say expectations surrounding the outcome for this summit are extremely low, with market seeing focusing on the hole and not the potential donut. However we believe that typically, in such scenarios the likelihood of an upside surprise is good.

Realistically no one expects Germany’s Angela Frau Merkel to wave a magic wand and grant everything, but the pressure has intensified on Europe’s leaders to find winder embracing solutions to the crisis.

George Soros’ proposals which we blogged yesterday might prove to be the catalyst to provide a spark of inspiration to an out-of-touch and fearful European political class bereft of ideas. One point worth making about George Soros is that he has credibility with the politicians after famously breaking the Bank of England in its attempt to shore up the pound during the early 1990s.

In an interview with German online newspaper Der Spiegal yesterday, Soros warns that Germany is in danger of “making an historical tragic mistake.”

“With the EU summit set to start on Thursday, pressure is on European leaders to find a way out of the euro crisis. Investor George Soros is pessimistic that a solution will be found and says time is extremely short. In an interview with SPIEGEL ONLINE, he warns that Germany could develop into a hated, imperial power.

SPIEGEL ONLINE: In Germany, once the motor of European integration, people are openly discussing the possibility of leaving the euro zone. Many Germans believe that a return to the Deutschmark would be cheaper than to remain stuck in a flawed currency union. Are they right?

Soros: There is no question that a breakup of the euro would be very damaging, very costly, both financially and politically. And the biggest loss would be incurred by Germany. Germans have to bear in mind that, effectively, they have suffered practically no losses so far. Transfers have all been in the form of loans, and it is only when the loans are not repaid that real losses will be incurred.”

There is no mistaking this is an important cross road for the markets.

A clear and realistic plan to deal with the immediate sovereign debt and banking crisis and a roadmap to the longer-term objective of further integration would be greeted favourably. But it is not just the markets the political elite must engage with and convince, but also the voters for the European project to have any hope of success.  Many would still clearly remember the way the Lisbon Treaty was imposed – especially in Ireland, and worse still in Britain. This would be true democracy, but it will take time – Rome, after all, was not built in a day.

Yesterday Cyprus officially became the fifth Eurozone country to seek a bailout of up to €10bn, while this morning Italy sold nearly €3bn worth of zero-coupon securities with a 2014 maturity at a yield of 4.71%, compared with 4.04% previously and Spain sold €3.08bn in three-month bills for a yield of 2.36% compared to 0.85% in May.

In the US, Wall Street was up in early trading. The S&P/Case-Shiller index of property values in twenty US cities dropped by 1.9% in April, which was less than the median 2.5% forecast and the smallest fall since November 2010. However the Conference Board’s consumer confidence index fell from 64.4 to 62 for this month versus the 63 consensus.

Lastly, despite the importance of the outcome of the summit and the considerable amount at stake for the financial markets the VIX remains subdued around 20, which is unusual and also encouraging for equities.