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May 28, 2017

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EU policymakers need to think big

NEW YORK -- So much for the relief rally.

After bouncing overnight on news that Europe had stitched together a US$125 billion rescue for Spain's banks, gains for global stocks and the euro fizzled.

Bailouts for debt-strapped countries have provided a short period of comfort for investors, one that quickly gets eroded by fear about Europe's vicious circle of slow or no growth and growing debt burdens. On Monday, the speed of that reversal was quicker than ever.

Greece's first bailout in 2010 sparked a healthy 1.3-percent rally in the benchmark Standard & Poor's 500 stock index on the following day, but subsequent rescues fostered more muted responses.

The reaction after Spain's bank bailout has been the most downbeat of the lot, particularly given the size of the package and the speed with which gains were wiped out. U.S. stocks fell into negative territory within an hour of Monday's opening bell and then continued dropping.

"Even the most inconsolable and bearish analysts were taken aback at how decisively markets rejected this bailout," said Richard Franulovich, currency strategist at Westpac Securities.

U.S. stocks fell 1.3 percent, and the euro shed 0.2 percent, while Europe's leading index of blue-chip shares and Spain's IBEX 35 declined.

The four prior bailouts — for Greece and Ireland in 2010, Portugal in 2011 and Greece again in 2012 — showed the euro's rallies fade within a month, while stocks were mixed, based on various factors.

In the credit default swaps market, where investors take out insurance against the risk of sovereign default, the pattern has been similar. The cost of buying insurance against Greek, Irish or Portuguese default tended to drop after the first two weeks as investors took the bailout news as a sign of relief, only to rise back to pre-bailout levels or higher within a month.

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