The EUR/USD and risk sentiment in general remain quite choppy today following a burst of optimism yesterday on reports that the EFSF would be leveraged to a figure around €2 trillion or more. That reporting was debunked later in the session, but it left a positive reinforcement that over the weekend we will see a grand plan to help ease the sovereign debt crisis.

EFSF Leveraging Likely to Be Near €1 Trillion

The latest reporting today however shows that the the leveraging of the bailout fund is unlikely to exceed €1 trillion and as a result we continue to see rumor and headline driven trading ahead of the weekend European Summit.

From SF Gate: German Finance Minister Wolfgang Schaeuble told lawmakers in Berlin that the firepower of the European Financial Stability Facility may be increased to a maximum of 1 trillion euros ($1.38 trillion) through an insurance model, Financial Times Deutschland reported.

The main outline of the plan currently revolves around an insurance plan for periphery sovereign debt. The euro zone countries would ensure the first 20% of losses on periphery bonds bought by private investors. This is an attempt to restore confidence of private investors as well as other entities like sovereign wealth funds to continue to participate in funding countries such as Italy and Spain.

For France, Complications Abound

Complications remain. For the French a larger write-down of Greek debt, which is one of the key proposals of the plan this weekend, would mean that the French government would need to provide more capital for its banking system which has a lot of exposure to Greece. The larger the write-downs the more capital would be required.

This week we had reports that France's AAA rating may be in danger considering the new liabilities France would have under a leveraged EFSF as well as the need to bail out its banking sector.

From Financial Times: Plans to give the European financial stability facility, the eurozone rescue fund, extra firepower would put the French economy under more strain as it is likely to mean more guarantees.

Moody's said the deterioration in French debt metrics and potential for further contingent liabilities - that is, possible additional support to other EU countries or to its own banking system - were exerting pressure on the stable outlook of its rating.

While market participants may be giving European leaders the benefit of the doubt, the idea that's countries such as Italy and Spain will self-insure themselves via the EFSF strain credibility.

French President Sarkozy is traveling to Frankfurt to meet with Germany's Merkel as well as ECB policymakers.

From Reuters: French sources later confirmed Sarkozy would travel to Germany, where he is also expected to meet outgoing European Central Bank President Jean-Claude Trichet.

While France has argued the most effective way of leveraging the firepower of the European Financial Stability Facility is to turn it into a bank which could then access funding from the ECB, both the central bank and the German government have opposed this.

One of the rubbing points for a for the weekend plan is that France would like to see the EFSF become a bank so it could borrow from the ECB, which take central bank is adamantly against since it would mean in essence monetizing debt.

Greece Headed For Managed Default

Further headlines today showed that Moody's believes there is no way that Greece can avoid a default.

From ForexLive: Moody's: No Way For Greece Not To Default
According to an analyst named Cochrane, quoted by Bloomberg.
Greek bondholders are likely to see a 60% haircut, according to the analyst.

This has been the position taken by Germany and in the latest press conference between Merkel and Sarkozy, Sarkozy did not reiterate his earlier statement that a Greek default should be avoided at all costs. A write-down of its 50 to 60% would be categorized as a default. Today in Athens we saw a large street protest with protesters clashing with police.

Will European Plan Under Perform Expectations?

Overall what where this this leave us? While market participants may be less concerned about overall impact of your zone sovereign debt crisis compared to September, is a strong chance that it may also be setting themselves up for disappointment following the meeting.

It seems that rumors about these plans tend to have a bigger impact than the actual announcements. we've been here before with European leaders where they over promise, release the market reads too much into their statements, and then the actual agreement tends to under perform the market expectations.

From Businessweek: The upgraded facility may still prove too small to deter investors from targeting the bigger economies, according to Mackie, who calculates that given its existing commitments, the fund has about 270 billion euros left. His figures suggest that with Italy, Spain and Belgium facing funding needs of more than 1 trillion euros over the next three years, guaranteeing the first 20 percent of losses would leave less than 100 billion euros for other fire-fighting tasks.

The EFSF might not have the resources to help recapitalize Europe's banks, another issue that European leaders have pledged to address. And it would face highly concentrated and correlated risks by insuring the debt of multiple European countries with high debt levels like Italy, Spain and Belgium, said Jacques Cailloux, the chief European economist at Royal Bank of Scotland Group Plc in London, in a research note.

EUR/USD is Sideways as Market Awaits the Weekend Summit

The EUR/USD, has been moving mainly sideways in this week's session after strong rally the previous two weeks. The pair has held at 200 moving average the one-hour timeframe was unable to move to new highs set early in the week at 1.39.

We may have to take our cues for the pair therefore following the weekend especially if we have a break to the topside of that 1.39 level or a break below 1.3680 which has set up as support.

width=669

Nick Nasad is the Chief Market Analyst at FXTimes - provider of Forex News, AnalysisEducationVideosCharts, and other trading resources.