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To say market expectations for the proposed European Union recovery fund are high is a bit of an understatement.
Since the initial Franco-German proposal for joint debt issuance was announced on May 18, the Stoxx Europe 600 SXXP, -0.46% has climbed 13%, and the euro EURUSD, +0.16% has zoomed from the $1.08 level to flirting with the $1.14 mark.
Importantly, yields on 10-year Italian government debt TMBMKIT-10Y, 1.180% have fallen from 1.85% to 1.18%.
It is true that other things have happened during that time period, as well, notably a rapid decline in Europe, particularly compared with the U.S., in the number of new coronavirus cases and deaths. But expectations for the proposed 750 billion–euro fund from the European Union are not small.
“Ever since the creation of the eurozone, the one massive, massive, problem is that there is no fiscal union,” said Daniel White, senior research and strategy manager at Canada Life Investments, in a recent interview. “This is possibly the very first step toward that resolution.”
As European leaders meet on Friday and Saturday, the key will be whether the region’s economic leaders, France and Germany, can overcome the opposition from the so-called Frugal Four, comprising Austria, Denmark, the Netherlands and Sweden.
Analysts at French bank BNP Paribas say agreement will be reached — though possibly not this weekend. They say “principles” may be reached, though another emergency summit may be required.
“We maintain that the deal will keep the essence of the Franco-German and European Commission proposals, including: disbursement over three to four years; a preponderance off grants over loans; and a split favoring the Mediterranean economies, at least on the margin,” they said.
In typical European compromise style, one compromise could be to keep the headline €750 billion figure of the fund, while lowering the long-term budget on which the fund is supposed to add.
And the fund isn’t exactly front-loaded. The EU proposal is for as little as €120 billion to be raised next year.
But the symbolism may be as important as the semantics. “As important as the fund is, we should also bear in mind the broader objective of signaling European solidarity and establishing a framework for risk sharing that could be revisited in future crises,” said Hetal Mehta, senior European economist at Legal & General Investment Management.
By Monday, markets may have rendered a verdict.
“Expect an overt thumbs-up or thumbs-down by eurozone investors on Monday, depending on what [the weekend] meeting concludes,” said Chris Bailey, European strategist at Raymond James.
