After more than 2 years of the euro crisis coming and going, something of a catharsis is possible with the next Greek elections and its potential exit. The Spanish bank bailout announced over the weekend is part of the effort to isolate the rest of the Eurozone from a potentially very negative shock. Markets clearly wonder if this is all there is as a firewall. Unfortunately, Europe continues to move too slowly and timidly towards its goal of integration and preservation of the euro.

At the same time, there is a new element, which we call the ‘Hollande effect’, which is a move towards flexibility and growth away from strict conditionality and austerity.

The bailout for Spanish banks is a welcome decision, but it does not mean a drastic change in the plausible scenarios for the next weeks/months. The size of the banks bailout (100 billion euros) seems basically OK relative to most independent estimates of the recapitalization needs. The IMF estimated that in an adverse scenario Spanish banks would need 40 billion euros, though that estimate is not all-inclusive. Fitch and S&P produced estimates in the 90-100 billion euros range, while Barclays stated that in an extreme scenario it would need 126 billion euros. These numbers are estimates of the capital injections needed to compensate for the losses (mostly from real estate loans) in order to bring capital up to high and acceptable levels (in some, straight to Basel III). The new bailout adds to the overall funds available for Spanish banks, making that side of the story acceptable.

The reason why this announcement cannot materially change scenarios is that it does not improve the sovereign’s growth or fiscal outlook. More practically, it does not mitigate the risk for a bank run triggered by the potential example of Greek banks collapsing (or converting deposits to a new local currency, possibly after a freeze). This points back to our earlier posts, without a pan-European deposit guarantee, depositors would be rational to move their savings to Germany.

On the positive side, with this bank bailout, the Spanish government net issuance requirements are almost nil for the rest of the year, though they do need to refinance maturities. Spain’s 10-year government bond rate is one key variable to watch for the effectiveness of these measures. Judging by today’s market for Spain’s 10-year bond, which rate rose almost 30bps, while global equity markets ended up not only erasing overnight gains but in negative territory for the day, a solution is still elusive.

However, this announcement can signal there is awareness that Greece can produce a meaningful shock and that protecting Spain in advance is key. Over the weekend, German newspaper Der Spiegel had an article saying there is a top working group (including Draghi, Junker, Rhen, etc.) preparing a broader plan along the lines of our previous articles, with banking integration, fiscal integration, which requires further political integration. If that article was roughly representative of what is in the works, then Greece becomes less relevant, the euro can survive, and the rest of the world can go back to look at their assets upon their own fundamental merits. True that we are now in a lower growth world than what we thought it would be 3-6 month ago, but May’s selloff has produced clear divergences between markets and what reasonable medium-term valuations should be.

The calendar ahead is event-heavy, with Greek elections this Sunday, followed by an EU finance ministers’ meeting on the 21^st, followed by an EU leaders meeting on the 28^th, etc. The debate and rhetorical announcements point in the right direction. But Germany still resists admitting that the timing for integration is now. The EU policy makers have a poor track record on timing. As we have said before, the direction is correct, the problem is the pace and size of each announcement. Because of this, we remain cautious, with our allocation to equities well below 30%, commodities below 8%, and international diversification reduced.