Another volatile day was driven by headlines about the upcoming EU summit. Now that policymakers announced that no decision will be announced until after the second meeting on October 26, the summit during the weekend should catch less attention. Germany's chancellor Angela Merkel cancelled a speech to Parliament on Friday, suggesting the lack of agreement on a solution. It appears that the major division between Germany and France remained on leveraging the EFSF. Later in the day, leaders of the 2 countries released a statement announcing a plan for reaching an agreement and this lifted sentiment modestly.
Regarding EFSF leverage, France suggested giving it bank license so that it will be able to use sovereign debt holdings as collateral against borrowing from the ECB. While both French president Sarkozy and finance minister Baroin strongly recommended the move, it was opposed by the ECB, Germany and the Netherlands. Bundesbank President Jens Weidmann said its 'very dangerous' to give the European Financial Stability Facility a bank license because it could amount to monetizing the debt of distressed governments. Bundesbank President Jens Weidmann said 'a bank license would mean monetizing state debt' and it is 'very dangerous' to give the EFSF a bank license because it could amount to monetizing the debt of distressed governments'. Germany seems to favor the idea of using the EFSF to guarantee a potion of each debt issue (say 20-30%). While this would allow the EFSF funds to be stretched further, the impact on the market may be minimal.
In the statement released earlier, the 2 biggest economies in the Eurozone pledged 'to provide a comprehensive and ambitious global response to the current crisis in the Euro area. This response will include the following: the operational implementation of new forms of intervention EFSF; a plan to strengthen the capital of European banks; the implementation of the economic governance of the euro area and the strengthening of economic integration'. Regarding to the Greek situation, the 2 countries 'call for immediate negotiations with the private sector to reach an agreement for strengthening sustainability'. It's also stated that a second meeting will be held on Wednesday for the response to 'be finally adopted by the Heads of State and Government'.
On the dataflow, initial jobless claims fell to 403K in the week ended October 15 from an upwardly revised 409K in the prior week. The 4-week moving average dropped -6K to 403K, the lowest level since April 16. Philly Fed survey surprisingly returned to expansionary territory, rising to +8.7, in October from -17.5 in the prior month. The market had anticipated only a modest improvement to -9.5. Existing home sales fell -2.9% to 4.91M in September, largely in line with expectations.