Knowledge. Shared Blog

July 2020

A Historic Day for Europe

Paul O’Connor, Head of the UK-based Multi-Asset Team, responds to the European Union’s landmark coronavirus recovery package, agreed to after four days and four nights of negotiations.

Key Takeaways

  • The plan will include €390 billion of grants and €360 billion of loans, with almost a third of the funds being earmarked for targeting climate change.
  • The direct impact of the €750 billion recovery fund will be modest relative to the damage wrought by COVID-19, but the symbolism is important. The recovery plan will be financed by joint debt issuance, representing the eurozone’s first attempt at mutualizing debt.
  • While the agreement was already somewhat priced into financial markets, investor sentiment toward Europe seems to be improving.

The deadlock has been broken. After four days and four nights of negotiations, European leaders have reached an agreement on a recovery fund to help the eurozone overcome the economic impact of the coronavirus pandemic. The plan will include €390 billion of grants and €360 billion of loans, with almost a third of the funds being earmarked for targeting climate change. European Union leaders also reached agreement on the next seven-year budget, which will be worth over €1 trillion.

The direct macroeconomic impact of the €750 billion recovery fund will be fairly modest compared to the economic damage wrought by COVID-19 on the eurozone economies. While consensus forecasts estimate that eurozone real gross domestic product contracted 15% year-on-year in the second quarter of 2020, the recovery fund is expected to deliver a 6%-7% boost that will take months to materialize and years to have its full effect.

Still, the symbolism here is very important. The recovery plan will be financed by joint debt issuance, representing the eurozone’s first real attempt at mutualizing debt and its biggest step yet toward fiscal integration. While skeptics believe that the recovery package is a one-off response to a one-off crisis, an important precedent has nevertheless been established regarding how the eurozone can respond to economic shocks. There will undoubtedly be great pressure to move further in this direction the next time that the region faces an economic crisis.

The modest market response this morning to the summit news reflects the fact that some sort of agreement had already been priced into financial markets. While investors were not confident that a deal would be reached at this summit, consensus expectations were that agreement would be reached by the end of July. The positive sentiment that has emerged regarding eurozone assets in recent weeks has carried the trade-weighted euro close to a one-year high and has pushed the Italian-German government bond yield spread back down to pre-pandemic levels.

We see scope for further outperformance of eurozone assets from here. Although sentiment has already improved regarding the region, investor positioning is by no means excessive. Global investors have begun to reinvest in European stocks in recent weeks, but the region has seen €30 billion of net outflows this year and three years of trend outflows from European equity funds.

Furthermore, while many features of the eurozone economic and political backdrop have paled in comparison to the U.S. in recent years, the tide seems to be turning here. Europe has handled the coronavirus much more effectively than America and, for the next few months at least, can reasonably be seen as offering global investors a refuge from the political storms that lie ahead in the U.S.

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