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When the European markets opened for trading this morning, the euro surged to a high of 1.3954 against the U.S. dollar but as the session progressed and details of the EU response to the crisis trickled into the markets, the EUR/USD's gains disappeared with the currency pair starting the North American session lower than where it ended on Friday.  Although the early details from this weekend's EU Summit show that we are getting closer to a comprehensive rescue plan for the region, European officials are sharing too much with the market and are  quickly losing the element of surprise.  Up until this weekend, their dismissals of various rescue plans revealed to market by the media worked to their advantage because it led investors to believe that a large and ambitious package of measures would be unveiled by the end of the EU Summit.  The Summit is still underway, but the lack of explicit numbers and hard proposals so far is proving to be a disappointment.   Here's what we know about the new rescue fund so far:

1. The ECB's balance sheet will not be used to increase the rescue fund

2. The dollar amount of bank capitalization will be between EUR100 to 110 billion with a core capital ratio target of approximately 9%.  Banks will need to raise funds privately first before accepting government recapitalization

3. Haircuts of at least 50 percent on Greek debt

4. EFSF will not be turned into a bank

5. EFSF first loss insurance still being considered along with the creation of an SPV to attract foreign capital and the funds would be used to by EZ debt.  The goal is to raise between EUR750 to EUR1.25 trillion.  

With the size of bank recapitalization and the target for the core capital ratio at the upper band of the market's estimates, the EU's plan will at bare minimum meet the market's expectations. With the details of the Summit stripping away the EU's element of surprise, shock and awe can only come from the total sum of the rescue package.  Otherwise, the EUR/USD would be at risk of a buy the rumor, sell news type of reaction.  With that in mind however, we don't expect significant downside in the euro because the extension of the EU Summit reflects the seriousness of European leaders to finally solve the region's debt troubles.  The pressure is on for Europeans to deliver on Wednesday and officials will need to tackle the fundamental problems head on with clear and decisive action to permanently bring down bond yields and CDS spreads and lift the EUR/USD above 1.40.  Anything short of that will erase the gains in the euro.

Meanwhile to the frustration of Japanese policymakers, the Yen remains near a record high against the dollar, triggering widespread speculation of possible intervention by the Bank of Japan.  Although Japanese officials have stepped up their threats of intervention, the chance of intervention is lower than August (when the BoJ last intervened) because the amount of speculative net long positions in the Yen are at the lowest level since 2004.  The Bank of Japan typically intervenes in the Yen when net long positions are at extreme levels because they get the most bang for their buck by stopping out long yen short dollar traders in the process and right now Yen positions are not extreme enough to give them that advantage.

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.