Germany's Upcoming Court Ruling Will be Huge for the EU

On September 12, the German Constitutional Court will rule on whether the European Stability Mechanism (i.e. the bailout fund) is compliant with the country’s constitution, Business Insider’s Joe Weisenthal reports.

Should the court rule in favor of the ESM, then the bailout fund will become operational and available to all the ailing nations in the eurozone. However, should the court fail to ratify the bailout fund, well, then EU leaders will have to come up with something else.

And while most analysts say there's a very slim chance the court will shoot down the plan, Morgan Stanley’s Elga Bartch says those chances are greater than you think. In fact, Bartch says there's a 40 percent chance the court won't approve the ESM.

"That's a really big chance of a negative blow to what's seen as a decisive piece in the puzzle," Weisenthal notes.

But let’s go back for a moment and examine what would happen if the court votes down the bailout fund. Morgan Stanley's Laurence Mutkin and Elain Lin give us a little insight:

Should the ESM ratification fail, the immediate reaction would be a sharp rise in the pricing of systemic euro-sovereign risk. Furthermore, the conditionality expressed by ECB President Draghi at the August ECB press conference means that if the ESM were put on hold, the ECB would struggle to justify active intervention in sovereign markets.

This should lead to a widening of peripheral sovereign spreads to levels seen before the August ECB meeting, and a concomitant re-flattening (bear flattening) of the credit curves.

However, the outlook for the very front end of peripheral sovereign curves is more complicated. On the one hand, the market could continue to price in some hope of ECB intervention at the short end of yield curves, notwithstanding the expressed conditions of the "Draghi put", as without them, the outlook for convertibility risk would rise very sharply. On the other hand, short-maturity peripheral yields have already fallen by 100-200bp and the short ends of peripheral curves have already steepened a lot since the "Whatever It Takes" speech; as we think that a positioning at the front end is already relatively heavy.

Simply put, months of work (i.e. arguing and haggling) by EU leaders would be undone and one of the last remaining options to deal with the global financial crisis would be null and void.

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 Front page photo courtesy the AP.