Today’s CIO Weekly Perspectives comes from guest contributor Patrick Barbe.
Two weeks ago, the German and French governments proposed a powerful rescue plan to restart economic activity across the whole of Europe after the COVID-19 crisis, with a focus on the most impacted sectors and the weakest countries.
Last Wednesday, the European Commission, the executive arm of the European Union, set out the rationale for the plan and the details of the proposed allocation of public funds. The total package would be worth €750 billion, or 4.5% of the EU’s GDP. Perhaps even more important, this would be the first time EU member states have contemplated a fiscal transfer between countries—and it therefore represents a key step toward the integration of the eurozone.
In the words of Commission President Ursula von der Leyen, “This is Europe’s moment.”
Since the crisis in the eurozone’s southern banking systems and economies in 2010 to 2013, those countries have lost many of their engines of growth in the real estate and industrial sectors due to low productivity. Despite signs of recovery in the past 18 months, the impact of the COVID-19 crisis means that northern economies with highly productive industries now look set to pull away even further from southern economies that have become dependent on investment flows. Moreover, the excessive debt taken on by southern countries to tackle the previous crisis prevents them from implementing a strong and credible fiscal boost today. To restart their economic activity efficiently, we believe external inflows of capital are needed—not burdensome additional debts.
Thus, the proposed package is split between a package of loans, worth €250 billion, and a much larger €500 billion package of “grants,” distributed to member states as an EU budget transfer. This will be financed mostly via issuance of debt by the European Commission on behalf of EU member states. The debt will be repaid from future EU budgets, to which Germany contributes the lion’s share.
Funds will be allocated according to the needs identified by the European Commission rather than following the usual European rules of the “capital key.” The capital key determines how much capital each EU member state contributes to back the European Central Bank, and since the eurozone crisis, it has been used to calculate the value of each country’s bonds the central bank can purchase as part of its quantitative easing programs. Unfortunately, Germany contributes the most capital, but the biggest benefit of the asset purchase programs has come from buying southern countries’ bonds.
By contrast, it is likely that Italy will be the biggest beneficiary of the new EU Recovery Fund, receiving €82 billion in emergency grants and up to €91 billion in low-interest loans. Spain looks set to get grants totaling €77 billion, Greece €32 billion, France €39 billion, Germany €30 billion and Portugal €18 billion. Southern European credit spreads tightened substantially on the news.
The southern countries have been making this case for fiscal transfers and jointly issued “Eurobonds” for years. This time, however, Germany is on their side, having recognized that COVID-19 has left no other choice; it represents such a major growth disruption that some countries simply could not recover alone.
We believe that the experience of 2010 – 2013 crisis is the key to understanding this new approach from Germany and the European Commission. They are now much more aware of the political risks within some southern eurozone countries and want to avoid feeding “populism” by allowing the economic crisis to worsen.
Nonetheless, the European rules are clear: Unanimity is required to validate a plan like this. We expect tough discussions as Germany, France and the southern countries try to persuade those still opposed, such as Austria, the Netherlands, Denmark and Sweden.
While the Commission’s proposal provides for the EU to collect its own revenues through digital or financial transaction taxes, that appears to be far from sufficient—72% of the EU budget is made up of national contributions. The agreement is therefore likely to require new taxes to co-finance the budget and help repay the debt, and it will be a challenge for politicians to tax their own citizens to support other countries. The only way to ease this is to give a lot of time to pay down the debt—the bonds to be issued will likely mature no earlier than 2027 and possibly as late as 2058—and appeal to solidarity.
The Recovery Fund proposal is the first major common fiscal project in the history of the EU. It will take time to be amended and unanimously ratified—we do not expect any implementation before the end of this year. But this is an important step. The ECB no longer stands alone in support of the eurozone. The politicians are finally taking their decision-maker seats.
In Case You Missed It
- S&P Case-Shiller Home Price Index: March home prices increased 1.1% month-over-month and 3.9% year-over-year (NSA); +0.5% month-over-month (SA)
- U.S. Consumer Confidence: +0.9 to 86.6 in May
- U.S. New Home Sales: +0.6% to SAAR of 623,000 units in April
- U.S. Initial Jobless Claims: +2.12 million in the week ending May 23
- U.S. Durable Goods Orders: -17.2% in April (-7.4% excluding transportation, durable goods orders)
- U.S. 1Q 2020 GDP (Second Estimate): -5.0% annualized rate
- Eurozone Consumer Price Index: -0.1% in May month-over-month and +0.1% year-over-year
- U.S. Personal Income and Outlays: Personal spending decreased 13.6%, income increased 10.5%, and the savings rate increased to 33.0% in April
What to Watch For
- Monday, June 1:
- ISM Manufacturing Index
- Wednesday, June 3:
- ISM Non-Manufacturing Index
- Thursday, June 4:
- U.S. Initial Jobless Claims
- ECB Policy Meeting
- Friday, June 5:
- U.S. Employment Report
Statistics on the Current State of the Market – as of May 29, 2020
|S&P 500 Index||3.0%||4.8%||-5.0%|
|Russell 1000 Index||3.1%||5.3%||-4.9%|
|Russell 1000 Growth Index||2.2%||6.7%||5.2%|
|Russell 1000 Value Index||4.4%||3.4%||-15.7%|
|Russell 2000 Index||2.9%||6.5%||-15.9%|
|MSCI World Index||3.7%||4.9%||-8.0%|
|MSCI EAFE Index||5.1%||4.4%||-14.0%|
|MSCI Emerging Markets Index||2.9%||0.8%||-15.9%|
|STOXX Europe 600||5.2%||5.0%||-15.5%|
|FTSE 100 Index||1.4%||3.3%||-18.2%|
|CSI 300 Index||1.2%||-0.9%||-5.3%|
|Fixed Income & Currency|
|Citigroup 2-Year Treasury Index||0.0%||0.1%||2.9%|
|Citigroup 10-Year Treasury Index||0.2%||0.0%||12.5%|
|Bloomberg Barclays Municipal Bond Index||0.2%||3.2%||1.2%|
|Bloomberg Barclays US Aggregate Bond Index||0.2%||0.5%||5.5%|
|Bloomberg Barclays Global Aggregate Index||0.8%||0.4%||2.1%|
|S&P/LSTA U.S. Leveraged Loan 100 Index||1.7%||3.4%||-3.8%|
|ICE BofAML U.S. High Yield Index||1.8%||4.6%||-5.7%|
|ICE BofAML Global High Yield Index||2.0%||4.7%||-6.0%|
|JP Morgan EMBI Global Diversified Index||0.3%||6.1%||-6.1%|
|JP Morgan GBI-EM Global Diversified Index||2.0%||5.2%||-7.3%|
|U.S. Dollar per British Pounds||1.4%||-2.0%||-6.7%|
|U.S. Dollar per Euro||2.1%||1.6%||-0.9%|
|U.S. Dollar per Japanese Yen||-0.2%||-0.7%||0.9%|
|Real & Alternative Assets|
|Alerian MLP Index||1.5%||9.0%||-30.2%|
|FTSE EPRA/NAREIT North America Index||4.6%||-0.3%||-23.6%|
|FTSE EPRA/NAREIT Global Index||4.8%||-0.1%||-23.5%|
|Bloomberg Commodity Index||1.3%||4.3%||-21.2%|
|Gold (NYM $/ozt) Continuous Future||0.9%||3.4%||15.0%|
|Crude Oil WTI (NYM $/bbl) Continuous Future||6.7%||88.4%||-41.9%|
Source: FactSet, Neuberger Berman.