ECB Sidesteps Resistance with IMF Loan Speculation

Dow futures spiked early on Friday morning when it was reported that the European Central Bank (ECB) might lend money to the International Monetary Fund (IMF). Speculation is that the money lent by the ECB to the IMF would be funneled back to Europe in the form of IMF aid. Many market commentators have called for the ECB to support indebted nations in the Eurozone, urging the bank to purchase the bonds of these nations. Thus far, the ECB has been reluctant to engage in bond purchases en-masse, although speculation is that they have purchased some Italian bonds when yields broke above 7%. Resistance has come from other European policy makers, particularly German bankers who are reluctant to allow any form of government financing with money printing. Germany experienced a bout of hyperinflation in the 1920s when the German Weimar Republic turned to printing money as a way to finance itself. That development led to tremendous upheaval in German society and policy makers have pushed for a strong currency ever since. The ECB may be able to sidestep that resistance by lending money to the IMF and then having the IMF lend that money to the indebted nations. While this strategy ultimately accomplishes the same thing, it puts the countries on the hook to the IMF and does not have the ECB printing money to pay bills directly. Still, will that be enough to solve the ongoing Eurozone crisis? The ECB is said to be willing to lend 200 billion euros to the IMF—less than $300 million. This may ultimately be nothing more than another stopgap measure, as some have argued that it would take a trillion euros in financing or more to solve the Eurozone crisis. The original bailout fund for the Eurozone—the European Financial Stability Facility (EFSF)—currently sits at just over four hundred billion euros. Late in October, as the situation intensified in severity, European officials unveiled a plan to leverage up the EFSF to a trillion euros. Unfortunately, that leverage requires a lender, and European officials have been unable to finalize a plan that would lead to someone putting up the money. Speculation has long been rampant that the money may come from Asia—specifically China. Yet, China has been dealing with its own issues. On Wednesday, manufacturing data indicated that Chinese manufacturing has been contracting at a rate greater than what was anticipated.

ACTION ITEMS:

Bullish:
Traders who believe that the ECB's actions will be successful in moving the crisis towards a resolution might want to consider the following trades:

• Go long industrial commodities. With the ECB crisis in less focus, global growth may have the chance to resume. That could be bullish for the price of industrial commodities.

• Make a play on European bonds. While an especially risky play if the crisis worsens, bond yields may pullback significantly if the market comes to believe that the Eurozone situation is coming to an end.

Bearish:
Traders who believe that the ECB's plan will solve nothing may consider an alternate positions:

• Short the US equity markets. The markets rallied sharply on Wednesday, and continued to move up on Friday. If the situation in Europe gets worse, these moves could quickly be reversed.

• Go to cash. The US dollar may strengthen in the event of a global financial crisis, similar to the situation in 2008.

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