After a brief bump caused by optimism surrounding the deal for a fiscal union last Friday, the markets took a look at the fine print of what exactly the EU had accomplished and today, found it wanting.
A European summit deal to strengthen budget discipline in the euro zone failed to restore financial market confidence on Monday, forcing the European Central Bank to step in again gingerly.
The euro fell, stocks slid and borrowing costs for Italy and Spain rose as investors weighed the outcome of last week's summit that split the European Union, with Britain blocking treaty change and forcing euro zone countries to negotiate a fiscal accord outside the Union.
Friday's initial market rally petered out in less than 24 trading hours due to legal uncertainty surrounding the new pact and the absence of an unlimited financial backstop for the single currency.
French President Nicolas Sarkozy said the legal basis of a new accord to enforce debt and deficit rules in the 17-nation euro area with quasi-automatic sanctions and intrusive powers to reject national budgets would be worked out before Christmas.
"In the next fortnight, we will put together the legal content of our agreement. The aim is to have a treaty by March," Sarkozy told newspaper Le Monde in an interview.
By March? March? But Italy has to roll over billions of debt in January:
The euro area faces the next potential crunch point in mid-January when Italy, which has a debt mountain of 1.9 billion euros or 120 percent of its annual output, has to start issuing tends of billions of euros in bonds towards a 2012 total of 340 billion euros needed to roll over maturing debt.
Michael Leister, rate strategist with German bank WestLB in Duesseldorf, said the summit outcome had done little to restore confidence in the absence of stronger central bank action.
The "legal content" of the agreement is the sticking point among the EU nations that will be part of the fiscal union. Because Great Britain has vetoed the notion of a formal EU treaty (any one of 27 EU nations can scuttle an agreement), the mechanisms of enforcement like the European Court of Justice cannot be used. Without the real threat of biting sanctions, what motivation would there be for a Greece or a France for that matter, to cut its budget to bring it in line with the new rules for a fiscal union?
Of course, without the Sword of Damocles hanging over the EU nation's heads, the market recognizes that very little has changed and have acted accordingly. Yields on 5 year Italian bonds soared over the danger level of 7% and 10 year bonds hit 6.8% while Spanish paper rose above 6%.
There is also little confidence that the European Central Bank will be armed with enough firepower to halt the contagion and intervene in a crisis. This, too, has contributed to the market's doubts that the agreement reached Friday has materially changed the outlook for the euro zone.