A report in The Guardian newspaper in London suggested France and Germany, Europe's two biggest economies, were putting the finishing touches on a massive expansion of the region's bailout fund, possibly to euro3 trillion ($4.1 trillion) from the current euro440 billion. That helped boost stocks in the U.S. late Tuesday.
The buying momentum carried through into Asia and Europe on Wednesday, though investors remain cautious in the run-up to Sunday's meeting of eurozone leaders in Brussels.
"Such suggestions were quickly met with rebuttals, however, it's been difficult to establish the veracity of either call, so for the time being at least, traders do seem to be taking the glass-half-full approach," said Ben Critchley, a sales trader at IG Index.
As I told a friend of mine yesterday, you can feel this market wants to rally but this European debt saga has to end once and for all. There was a report yesterday that a disagreement between France and Germany may prevent eurozone leaders from reaching a crucial deal on a second rescue package for Greece this weekend:
A common position of the two biggest eurozone economies is seen as a precondition for reaching agreement between all 17 countries in the currency union at a crisis summit on Sunday.
Investors around the world hope a comprehensive plan to fight the debt crisis, including final details on Greece's second bailout, will keep the debt turmoil from pushing the global economy back into recession. Signs that such a plan is proving slower to clinch caused markets to slide on Tuesday.
Germany is pushing for banks to accept cuts of 50 percent to 60 percent on their Greek bondholdings, while France is insisting that leaders should only make technical revisions to a preliminary agreement reached with private investors in July, the person said.
The person was speaking on condition of anonymity because of the sensitivity of the negotiations.
The July deal would lead to losses of some 21 percent on Greek bondholdings, much of that from cuts in interest rates and deferred payments.
While that would take some pressure off Greece in the coming years, it would do little to reduce Greece's overall debt load, which is set to reach more than 180 percent of economic output next year if the deal goes ahead, the person said.
German officials have said in recent weeks that the eurozone needed to find a solution for Greece that makes the country able to repay its debts in the long-run.
France on the other hand has been reluctant to back bigger losses for banks, since French banks are among the biggest holders of Greek government bonds. Its position is supported by the European Commission, the EU's executive.
Under the preliminary agreement reached in July, the eurozone would give Greece an extra euro109 billion in rescue loans. About one-third of that money would go into setting up expensive collateral funds for the banks that would secure them against any further losses on the Greek debt.
But because of worsened market conditions since July, setting up those funds has become more expensive. A revision of the deal would either have to result in bringing the costs for the eurozone back down or achieve somewhat higher cuts to the debt, the person familiar with the negotiations said.
The Institute of International Finance, the big bank lobby that has been leading negotiations of the deal, has said that banks would be unlikely to voluntarily accept much bigger haircuts on bonds than the 21 percent.
Charles Dallara, the managing director of the IIF, and Deutsche Bank CEO Josef Ackermann were in Brussels Tuesday for negotiations with eurozone officials, a spokesman for the institute said in an email, without giving further details.
But the person familiar with the negotiations would not rule out that private investors may eventually agree to bigger losses.
"It's not to say that because their first reaction was cold ... they will not engage in discussions," he said.
The second rescue package for Greece is part of a broader solution to the escalating debt crisis EU leaders have promised for this weekend. It will also include a deal to maximize the impact of the euro440 billion ($600 billion) rescue fund and higher capital levels for banks to make sure they can sustain market turmoil.
German Chancellor Angela Merkel tried to scale back expectations of the summit Tuesday, warning that the meeting was "an important step, but it is clear that further steps will follow."
The disagreement between France and Germany on the Greek rescue signifies a larger split between the two countries. France -- which finds itself increasingly under scrutiny by worried investors -- is concerned that having to help its banks suffer through Greek losses will hurt its own credit rating, while Germany seeks to limit bailout costs for its taxpayers.
Rating agency Moody's warned Tuesday that it might in the next three months start a review of France's credit worthiness, due to the country's worsened economic outlook and a growing crisis bill.
"France may face a number of challenges in the coming months -- for example, the possible need to provide additional support to other European sovereigns or to its own banking system, which could give rise to significant new liabilities for the government's balance sheet," Moody's said.
The warning came as French Finance Minister Francois Baroin said that the 2012 growth estimate of 1.5 percent was "probably too high." In an interview on France-2 television, Baroin blamed the risk of a global slowdown, which he said could be "very vast" and "severe."
Time is running out for resolving the European debt crisis. A double-notch downgrade of Spain's credit rating has piled pressure on European leaders to make convincing progress on solving the region's debt crisis at an October 23 summit. The blow from Moody's Investors Service came just a day after the agency warned France its triple-A rating could come under pressure and as Greeks began their biggest strike in years in protest at a painful austerity drive designed to avert default.
Another friend of mine who worked on a major infrastructure project in Greece shared these thoughts with me:
The Germans are right and there are few options left now. Greece's public finances have been a ponzi scheme for close to thirty years now.
The French government is stalling. This is bit concerning because it probably means the French banks do not have strong enough balance sheets to absorb the shock.
Anyone who believes that Greece can recover from this in short order does not understand sovereign lending. A whole generation of bankers will need to retire (probably die) before Greece regains any meaningful access to the sovereign debt markets.
Right now, Greece needs to cut the best deal possible. This will allow the government to return to some level of normalcy. After a haircut is implemented, the country will need to make difficult decision and prioritize. It will be impossible to maintain a civil service of 1.25 million when 300,000 should be sufficient. I think that the country will need to focus its resource on its most vulnerable citizens (the elderly and disabled on pension).
After the haircut, I suspect that growth in Greece will be severely constrained since there will be limited access to debt to drive investment.
Anyway, it is difficult to see a silver lining around all of this.
I don't share my friend's pessimistic view on Greece's ability to recover from this crisis but he's right, there is no silver lining and time is running out on EU leaders. The longer they wait, the more costly it will get for all parties involved. The global macro gods are rumbling and there are few options left. It's time for EU leaders to bite the bullet or risk throwing Europe and the world into another Great Depression. That is an outcome that must be avoided at all cost.
I leave you with a Bloomberg clip of Dino Kos, managing director of Hamiltonian Associates, Nicholas Colas, chief market strategist at ConvergEx Group, and Alessio de Longis, a portfolio manager at Oppenheimer Funds, discussing the outlook for resolving the European sovereign debt crisis.