The early returns are positive on what is arguably the most important week in Europe since at least 1999, when the euro was officially introduced.
Global stocks rallied and European sovereign debt yields tumbled Monday on hopes a big deal will emerge from the critical EU summit meeting in Brussels on Dec. 8-9.
In recent trading, the Dow was up 1.4% and Italian 10-year debt yields were below 6% vs. last week's peak of 7.89%. (Update: The rally effort hit a snag around 2 p.m. ET when The Financial Times reported S&P is planning to put the AAA credit ratings of Germany, France, the Netherlands, Austria, Finland, and Luxembourg on watch for potential downgrade.)
Ahead of the EU summit, Italy on Sunday adopted a new 3-year package of austerity measures that include pension reforms, higher taxes, spending cuts and tax breaks for companies that increase hiring. In total, the $40.2 billion package is equal to about 1.9% of Italy's GDP.
On Monday, Germany's Angela Merkel and France's Nicolas Sarkozy met in Paris to hammer out a plan designed to increase budget discipline and tighten fiscal unity in the eurozone. While they differ on the means to get there, Merkel and Sarkozy seem to be in complete agreement on the destination, fueling hopes for a "big" deal later this week.
In a press conference following their meeting, Sarkozy said the Franco-German agreement is complete and will be sent to Herman Van Rompuy, head of the European Council, on Wednesday, the FT reports. "Our preference is for a treaty with all 27 [EU members] so that no one feels left out, but we are ready to move ahead with a treaty with 17 [nations that use the euro] that others are free to join."
In essence, Merkel and Sarkozy will be asking EU members to renew their vows -- and really mean it this time -- to stick to targets for budget deficits and debt-to-GDP and the like. Like a person who's survived a serious illness, let's hope the Europeans have learned a lesson from their recent near-death experience and will change behavior going forward.
As Henry and I discuss in the accompanying video, the journey from here to there is going to be long and arduous.
First, while the cards seem to be falling into place, there's no guarantee any deal will be agreed to this week - certainly not one as comprehensive as currently anticipated.
Second, austerity measures like those adopted by Italy -- and Greece, Spain and Portugal prior - will put more strains on an already shaky European economy, at least in the short-term. Falling economic activity and tax receipts could put more pressure on sovereign debt yields, which remain elevated even after falling sharply in the past week.
Third, and perhaps most important, all the promises, pledges and austerity measures won't change the fundamental problems in the eurzone: The southern economies are uncompetitive with the northern ones and it's very difficult to get 27 EU members, with different nationalities, cultures and internal political considerations, to agree on much.
Despite these and myriad other challenges, hope for Europe springs eternal in the financial markets, at least as of this moment.
- Nicolas Sarkozy