When former Treasury Secretary Hank Paulson told Congress in 2008 that he needed a bazooka to convince the bond vigilantes that he had enough firepower to prevent any default, I knew he was right. Bond vigilantes have made nations cower many times. Half-measures can be fatal. Just ask Britain what George Soros did to them!
Greece in particular and Europe in general are trying to develop a bazooka of their own. Yesterday, the European markets rallied strongly on the news of new "deal." It is a complex deal and has taken some time to get thru it. Basically, it is another bailout of Greece, creating a bond exchange program for existing Greek bondholders. Existing bonds can be exchanged for a new bond with a face value that is 21% less, payable in 30 years but collateralized with zero-coupon bonds. For a lower interest rate, they can get a new bond with no discount but also with collateral.
If it stopped there, the bond vigilantes would start smelling blood and wait to pounce at the appropriate time. However, the European Financial Stability Fund now has authority to act pre-emptively to prevent the same problems in the PIIGS (Portugal, Ireland, Italy, Greece, & Spain). This could be important! Unfortunately, while the authority now exists, it is unfunded. Until funded adequately with a bazooka, the European sovereign debt crisis will continue.
The three pillars of uncertainty restraining the bull have been (1) the end of QE2, (2) the debt ceiling/budget issue, and (3) the European crisis. The first has been eliminated. The second will soon be resolved, one way or the other. The third still has at least one more act before the curtain comes down, and the vigilantes back off.
